Tightening Housing Supply

Share

In the coming years, an increase in Millennials forming households will create robust demand for both single family homes and apartments. Why inadequate supply over the long term may bode well for apartment REITs. The hunt for housing is heating up. In several U.S. regions, average houses spark bidding wars, apartments rent within hours and homes list at ever-escalating price tags. One driving reason: dwindling supply due to rising Millennial household formations.

Analysts say, “We’re going to see strong demand for housing, both multifamily and single family, over the medium to long term.” Aging Millennials, the largest segment of the U.S. population—are now forming households in increasing numbers, a trend that is expected to continue for at least the next five years. One question investors should consider revolves around why this coming imbalance between supply and demand may bolster both single-family home prices and multifamily rent growth in big cities and smaller towns. It may also open up some unexpected opportunities in apartment REITs for investors keen on riding this real estate wave, with the added bonus that apartment REITs tend to outperform during periods when the broader equity market draws down. Although multifamily and single-family housing prices are now past their pre-recession peaks, analysts say they don’t expect a housing correction in the next five years.

According to research, income levels and total housing supply are key factors, but the outsized Millennial population and household formation trends underpin a coming surge in demand. Builders have been working hard to keep up, but this population surge will eclipse their efforts. Research also forecasts that the growth of apartment stock will slow by 2019 to around 1% annually. Meanwhile, as new single-family homes continue to come onto the market, the existing supply is contracting, with 110,000 fewer homes on the market last year than the year before. Not only that, but research also found that apartment REITs could be a smart defensive tool for investors. Regardless of the pending population drivers, the report found that apartment REITs tend to outperform in times of equity market dips.

Digital Banking

Share

While consumer-facing tech like real-time payments and mobile banking hold great promise for banks, updates to behind-the-scenes infrastructure could be the key to cost savings and competitive advantage. With improved regulatory clarity and the prospect of normalized interest rates, technology will be the future battleground of differentiation for both consumers and investors. As an example, most bank consumers in developed markets are expected to have access to real-time payments by the end of 2018 allowing banking transactions to be completed with a swipe of the smartphone. But customer-facing applications aren’t the only differentiators that investors should be watching. As mobile banking increases customer traffic, having efficient scalable back-end systems becomes critical. Behind the scenes, digitization in banking has the potential to boost back-office efficiencies, reduce operational risk and improve profitability.

Over the long term, tech advances such as artificial intelligence (AI) and blockchain will clearly play a role in the evolution of banking. However, modernizing the infrastructure backbone that is, the core banking systems which handle the backbone of a bank’s activities, such as deposits and credits is the most important step banks will need to take. In order to remain competitive, banks will need to update technology on the back end in order to deliver a seamless experience on the front end since customers will have little tolerance for glitchy apps no matter how sleek the user interface. Investments in cloud computing and robotic process automation (RPA) should also take priority. Both of these investments offer an immediate opportunity for cost savings in the back office, while at the same time putting banks in a better position to compete with FinTech’s.

To better gauge infrastructure spending, analysts recently analyzed IT expenses over the last five years and earnings call transcripts over the last two years to better understand how banks are spending their IT budgets, gauge their progress against their competitors, and identify banks with the highest potential for improvement:

Core banking systems: With many banks still operating off a patchwork of legacy systems, most banks will need to make some improvements to their backbone. Migrating to a state-of-the art core banking system could reduce cost/income by 9%.

Cloud computing: Most of the banks are moving to the cloud, which offers the potential to shrink relevant infrastructure costs by 30% or more. Leaders have already moved 10% to 40% of their servers and operating systems to the cloud, and many are targeting up to 80% by 2020.

Robotic process automation: Among all of the technologies on the table, RPA may have the greatest potential in the near term. Put simply, these applications (robots) transfer information from one system to another, automating processes previously handled by humans; this can include everything from customer onboarding and payment reconciliations, to fraud prevention and compliance reporting.

 

Streaming Services & Broadcasting Changes

Share

With Netflix missing subscriber count estimates in the most recent earnings report published by the company, and Walmart announcing a attempt to join in the streaming service industry, the market is developing contrary to expectations. The overall shift afoot is due to the change of way TV content is consumed, causing revenues generated from pay-TV in Britain to fall for the first time after years of sustained growth.

According to BARB Establishment Survey data, the big companies in Britain – Netflix, Amazon and NOW TV-  totaled a subscription count of 15.4 million subscribers in the first quarter, more than the 15.1 million pay-TV contracts the old industry holds. The numbers look rosy for new entrants, but investors should keep in mind that traditional pay-TV still generated significantly higher revenues than video-on-demand subscriptions. Pay-TV subscription revenue totaled over 6.4 billion pounds in 2017, which was down 2.7% from last year, but heavily beats the 895 million pounds generated by video streaming services.

In terms of user data, time spent watching broadcast television on a TV set decreased. Currently, the average figure is 3 hours 22 minutes a day, nine minutes lower than 2016’s and 38 minutes since 2012. Meanwhile, mobile devices are becoming increasingly popular among 16-34-year-olds. Less than 50% of this demographic (whose average watching time is 4 hours and 48 minutes) utilized broadcast content. 

Keith Knutsson of Integrale Advisors commented, “The transition in viewing habits has broadcasting industry titans shifting strategies. Whether the broadcasting industry’s fate will assimilate those of railroads is to be seen, but with appetite in acquisitions the current leaders in streaming might see competition ramp up.”

Could Internet Sales Tax be a Good Policy?

Share

In the past, online retailers were able to take advantage of a tax shelter that exempted them from sales taxes in states that they did not have a physical presence. Online retailers used this tax shelter to challenge entrenched incumbents and provide consumers with a bounty of new options. However, the tax shelter for online retail is being revoked. Looking at this more closely, it all seems pretty enlightened policy-making. Startups were given a leg up that increased competition and consumer choice, and once they succeeded, it was taken away. However, critics could argue that the tax shelter should have been taken away a decade ago. Keep in mind, Amazon.com Inc. started collecting sales taxes a year ago in anticipation of this internet tax shift.

Instead of letting the elected members of the Congress initiate the plan, it was done entirely by the people appointed by the president to decide legal disputes. Looking at previous cases, the U.S. Supreme Court held that mail-order retailers with no physical presence in a state shouldn’t have to collect sales taxes from customers in that state. The reasoning behind the other cases was that “state taxation falling on interstate commerce can only be justified as designed to make such commerce bear a fair share of the cost of the local government whose protection it enjoys.” This means that if a retailer had a store or even just a few employees in a state, it was deemed as enjoying the protection of the local government and thus obliged to collect sales taxes. Recently, the Supreme Court changed its mind, “modern e-commerce does not align analytically with a test that relies on the sort of physical presence defined in Quill. E-commerce has grown into a significant and vibrant part of our national economy against the backdrop of established rules, including the physical-presence rule. Any alterations to those rules with the potential to disrupt the development of such a critical segment of the economy should be undertaken by Congress.” The Supreme Court has basically done Congress’ job, thus crossing the line built between the two entities.

As the Supreme Court now becomes in charge of e-commerce policy making, it could create problems between Congress and the Supreme Court for other tasks going forward. Investors should be wary that Supreme Court tax shifting is not one of the biggest problems in the year but could lead to distortion in the future.

 

Side Effect of Rising Oil Drilling

Share

Higher oil prices are hurting companies that frack for natural gas while American shale drillers benefit at the same time. As companies unearth gas as a byproduct, they respond to rising oil prices by drilling more of it. This has weighted on already low gas prices thus adding more pressure to shale frackers in regions that primarily product gas. The average share price for the five top companies focused on the oil-rich Permian Basin in Texas and New Mexico are up more than 16% over the past year. Share prices for the top five producers focused on the Marcellus Shale in Appalachia, the country’s largest deposit of natural gas, are down more than 9%.

Similar to shale drillers, those focused on natural gas in the Marcellus – a group that includes Cabot Oil & Gas Corporation, EQT Corporation and Southwestern Energy Company have been under investor pressure to live within their means. According to S&P Global, “Those companies have spent about $106 million more than they made in the first quarter of 2018. That has been down from outspending cash flow by more than $274 million in the previous quarter and more than $735 million in the first quarter of 2017.

Investors are reluctant to put more money into gas drillers because gas has been cheap for years and doesn’t look primed to go up soon. Demand for natural gas is predicted to rise globally over the next decade as many countries switch from coal-fired power plants to gas-powered ones. It is predicted that U.S. gas production will outpace domestic consumption through 2009. In terms of numbers, natural-gas futures for July delivery closed at $2.939 million British thermal units on Tuesday and has been below $4 since 2014. Investors should consider the potential of average prices staying below $3 for years, meanwhile U.S. oil prices climb to more than $65 per barrel for the first time since 2014. For most companies, the ongoing strategy has been to cut costs and squeeze out efficiencies over the past years while weathering the storm.

Prices for gas-focused shale companies have rebounded a bit since earlier this year with investors having potentially seen a bottom for gas producers. These companies are no longer buying and growing for the sake of it. It is left to the investors discretion if the market has gotten too bearish on natural gas or not.

China Gets the Upper Hand in Trade War with the U.S.

Share

Despite the powerful trade disputes that put China in a vulnerable position, Beijing has played their hand far better than the United States. Last weekend, the U.S. agreed to temporarily suspend tariffs up to $150 billion in Chinese imports. The strategic play by President Donald Trump has economic, political and strategic logic that his confrontations with Canada, Western Europe and Japan lack. However, China still appears to have a stronger hand as it successfully escaped the bulk of U.S. tariffs while giving up almost nothing of substance. With the temporary pause in the trade war, China agreed to buy more energy and agricultural products. This is not a disadvantage for the leading nation because buying more commodities from the U.S. will likely just redirect some sales that would have happened anyways.

China has successfully dodged a bullet by shrewdly exploiting President Trump’s weak points like his low threshold for political pain and his hopes for a breakthrough with North Korea, a Chinese client. The promised amount of purchases from the U.S. might successfully trim its trade surplus with the U.S., but tariffs of up to $150 billion is a bit too high.

U.S. officials say, “If we don’t get what we want, the president can always put tariffs back on.” The U.S. Treasury is finding ways to restrict Chinese investments in the U.S. while China has said it would allow foreign car manufacturing companies to take on their manufacturing needs moving forward. However, China has found subtle ways to promote its domestic champions over foreign rivals. The problem for the U.S. is that China has been buying more of the products that it needed to buy no matter the case.

Though the U.S. depends much less on exports to China than the reverse, China targeted farm exports from Republican states important to the outcome of midterm elections. This could be one reason why officials have prioritized avoiding Chinese retaliation. President Trump still claims that the actions taken against China in a trade war might “entail a little pain”, but the current conditions with China and the U.S. beg to differ. The important question for investors is whether China will be able to hold up against the highly disputed trade war with the United States or give in like other developing nations.

Macroeconomic Trade and Bonds

Share

              The market responded positively to President Trump’s comments on Chinese ZTE Corp. Investors see the comments as a sign for easing U.S-China trade tensions. The president made a statement that he would help ZTE get “back into business fast”, saying too many jobs in China were at risk. With concerns the high-level trade talks between the countries to resume with a potentially stronger tone after a tough stance on trade and tariffs, the chance of a potential trade war is being priced lower. Should negotiations break down, tariffs on tens of billions of dollars of products could appear before the end of next earnings season, with impact on earnings delayed but financial markets certainly instantaneous.

              Market noise should now increasingly be derived from real economic activity and experience less volatility from overtones of tariffs. Equity holders are now looking towards earnings seasons for changes in their portfolios.

              Macroeconomically, the government bond prices and the U.S. dollar fell, with the yield of 10-year U.S. Treasury note rising from 2.97% to 2.99%. After Friday, where the spread between US government bonds and the German Bund was the widest in roughly three decades, investors remain confident in economic growth in the US over that of Europe. Whether this trend of investor confidence will continue will remain to be seen. After all, the development of ultralow and in some instances negative rates in Europe could be increasing the appeal of US Treasury to foreign investors.

              Keith Knutsson of Integrale Advisors commented, “Investors should remember that the economic fundamentals in the United States remain superb at the moment.”

 

Tensions Arise in the Eurozone

Share

With tensions rising over trade disputes and the strengthening of the euro, the economy in the Eurozone has started to slow down. Taking into account all global market events, the European Central Bank (ECB) is now contemplating rate movement and rethinking its decisions on proceeding forward. Analysts have also dialed back their forecasts for when the ECB might increase short-term rates this year.

Trade disputes have been an important concern for the central bank because the Eurozone was successfully able to escape the trenches of a major debt crisis through the strong export system around the world. The Eurozone exported goods and services worth 44% of its economic output last year and had plans to do the same going forward. With the recent news on President Trump’s plan for tariffs, the Eurozone could face some headwind with its export business. Rising tensions around U.S. tariffs and an appreciating currency against the dollar has resulted in a temporary slowdown on rate adjustments within the Eurozone.

President Mario Draghi claims, “the banks will move only cautiously to withdraw its large monetary stimulus in light of trade disputes and a volatile currency. We are aware that an escalation of protectionist threats from the United States would dampen-growth everywhere and the recent uncertainty is probably already having some negative effects on investments.”

The ECB is set to meet this week to discuss current economic conditions and its next steps to decimate any major slowdown. Investors are planning on waiting for a potential rate hike to the second half of the year given the current ECB contemplation on short-term rates. The strengthening of the euro, which has appreciated roughly 15% against the dollar last year partly reflects U.S. policy decisions going forward. Investors are worrying about the Federal Reserve’s plan to offload balance sheets and its current budget deficits. As of now, the Euro and Yen might be safer options for investors looking into safer investments to diversify their portfolio with global currencies.

How Investors Should Navigate a Volatile Market

Share

With markets becoming increasingly volatile this year, investors have started to question their investment decisions. The year 2018 has been a surprise to investors as there was an initial selloff period and then a strong rebound.

The question is, will an increased market volatility serve to be a problem for investors?

Even though volatility might not be favorable to investors as the risks associated with an investment go up, volatility fluctuations have been based on the current U.S. business cycle. The U.S. economy is currently in the later stages of a long period of expansion that followed the financial crisis of 2008. Until the economy started to get on a firm footing, the U.S. witnessed lower interest rates, an improving global economy, a Federal Reserve Bank that showed reluctance in pulling back on unconventional monetary policies and events like quantitative easing.

More recently, we have seen a pickup in global economic growth, which has started to raise concerns about inflation and what it could mean for the markets going forward. Theoretically, small amounts of inflation are healthy for the markets. However, a sudden spark in inflationary risk could prompt the Federal Reserve Bank to halt expansion and put a stop on economic growth by increasing the interest rates. This will in turn affect the global markets and corporate profitability for companies around the world. The small increase in volatility compliments the increase in uncertainty and this has started to come up during portfolio decision-making.

Taking into consideration the past market cycle short and medium terms, we can predict that the market will head lower because growth will eventually stall. Recession is a feature of the market and is also completely common throughout the world. When this downturn comes up, the markets will decline, and losses might be incurred. With the correct hedging strategies, it is likely that investors will be able to successfully jump from this potential hurdle.

Some worried investors might ask, should we sell? The answer to this question is dependent on how risk-adversity. Nobody knows when the next recession might occur because there is no definite answer. Predicting an event like the recession is complex and at times inaccurate. Investors who take an aggressive approach to their portfolio will play with the risk-return strategy embedded in their respective portfolios, but the ones who might be risk-averse could lose major returns if the recession never hits. Instead, hedging your portfolio through diversification might seem like an optimal approach.

Another perspective to think about might be your personal goals. If investors have achieved their monetary goals, it might make sense to take a less riskier approach. Sometimes hedging your portfolio and riding out the market jitters is a better idea than to liquidate your investments because of the small subtleties of how the market is designed with respect to the economy.

Municipal Bonds Performance

Share

The first quarter of 2018 has been disappointing for investors due to concerns about rising interest rates, inflation, and newly established tax rules. In February and March, municipal bond mutual funds only saw an investment of $268 million – a 92% drop from the five-year average. In the past three months, a majority of municipal bonds ETFs have returned between a negative 1%-2%. A bad quarter for municipal bonds has not occurred in the markets since Q1 2008. Yet, despite concerns about such congruence, much of the effect is caused by lower taxes leading to lower demand for tax-exempt bonds.

Due to worrying purchasing powers, investors are looking towards newly issued bonds rather than outstanding bonds (only until the price of such securities falls). From a perspective of the government, low bond prices have resulted in rising borrowing costs on the state and local level.

Yet, there also remains optimism in the market; a bipartisan bill, aimed at reducing the reach of Dodd-Frank would classify municipal debt as high-quality liquid assets, is expected to pass. The National Association of State Treasurers has attributed higher borrowing costs for the government to the lack of exclusion from the high-quality liquid assets designation. Currently, the municipal bond spread results in a ~85% yield of comparable Treasury bonds, a value higher than the historical average.

Keith Knutsson of Integrale Advisors commented, “Given that lots of uncertainty remain regarding the deregulation of Dodd-Frank, it makes municipal bonds too speculative for the average investor currently.”