The homebuilding sector is one of the only bright spots in the market right now…
The S&P 500 is down 6% on the year. The Russell 2000, an index that tracks 2,000 small and medium-size publicly traded companies in the U.S., is down 12% since June.
Meanwhile, iShares US Home Construction ETF (ITB) is up nearly 5% this year. ITB holds a diversified basket of homebuilding stocks.
On Monday, Lennar Corp. (LEN) reported solid results…
Lennar is the second largest homebuilder in the U.S. The company’s second-quarter revenues rose 24% from the year before. Its new home orders rose 10%, while the average home price rose 5%. The company’s quarterly profit also rose 26%.
Lennar’s CEO said the housing market looks strong:
We continue to believe that the recovery in housing has been and will continue to be driven by strong and consistent demand. Employment is up. Labor is tight and wages are starting to rise. Millennials, who have been on the sidelines, are now starting to form households…
• Record low mortgage rates are helping the U.S. housing market…
Mortgage rates in the United States have averaged 8.39% since 1971. Last week, the average 30-year fixed mortgage rate was just 3.91%…
Seven years of near-zero percent interest rates have pushed mortgage rates to record lows. Regular readers know the Federal Reserve dropped its key rate to effectively zero in December 2008. It’s kept it there ever since.
When the Fed lowers its key rate, it makes borrowing money cheaper. Today, mortgage rates are so low that buying a house seems like a “no brainer.” The old question “Does it make sense to borrow this much money?” has been replaced with “How much can I get?”
Cheap credit has made the housing market “hot” again. It’s a big reason stocks in the homebuilding sector are going up when most other stocks are going down.
• And this is just one effect of easy money…
Morgan Stanley (MS) recently pointed out that Americans are doing silly things with their money…because credit is so cheap:
Consumers are feeling pretty good, and they are starting to spend money again, and they're starting to do dumb things. They're starting to borrow money, they're starting to maybe buy that house they shouldn't or that car they shouldn't.
• Regular Casey readers know that the Fed was widely expected to raise rates at its meeting last week…
But instead, the Fed decided to hold rates at effectively zero.
I almost fell out of my chair when I heard it…
A journalist recently asked Janet Yellen, the current chair of the Federal Reserve, if the central bank would keep interest rates at 0% forever.
Her response: “I can’t completely rule it out.”
The mainstream media largely ignored this comment…but it’s an important sign of how warped our economy has become.
The truth is, seven years of 0% yields and successive rounds of money printing has so distorted the U.S. economy that it can’t handle even the tiniest increase in interest rates. It would be the pin that pricks the biggest stock and bond market bubble in all of human history. The Fed cannot let that happen.
• Low rates are also fueling record-level buybacks…
A share buyback is when a company buys its own stock from investors. Companies in the S&P 500 are on pace to buy back almost $1 trillion worth of their own stock this year. That would be an all-time record.
Reuters explains how companies are borrowing cheap money to buy back their own shares:
Interest rates at near zero have increasingly prompted companies flush with cash to issue debt to fund share buybacks. Apple Inc, for instance, has issued $23.6 billion in debt this year despite having more than $200 billion in cash, part of its plan to buy-back up to $140 billion in shares by the end of March 2017. MetLife Inc., meanwhile, sold $1.5 billion in bonds in June to fund share buybacks, while having more than $10 billion in cash on its balance sheet.
The Wall Street Journal reports that tech giant Microsoft (MSFT) sold $10.75 billion worth of bonds in February to pay for buybacks. This spring, chip maker Qualcomm (QCOM) and database company Oracle (ORCL) both raised $10 billion in the bond market to pay for their share buyback programs.
• Buybacks can be a good thing for shareholders…
When a company buys its own stock, it lowers the number of shares on the market. This can make the company’s stock price go up.
But as Casey readers know, share buybacks are also a way for management to goose EPS numbers without actually improving the business. Buybacks can make the company’s financial results look better on paper…without creating real value.
One piece of data from Research firm FactSet suggests that buybacks have gone too far. FactSet reports that companies in the S&P 500 spent more cash on buybacks in the last quarter than the total amount of cash they generated.
Chart of the Day
Cheap credit has U.S. companies borrowing record amounts of money…
The Securities Industry and Financial Markets Association (SIFMA) reports that U.S. companies issued a record $1.4 trillion in corporate bonds last year. And they’re on pace to break that record this year…
Through August, U.S companies have already issued nearly $1.1 trillion in bonds. That’s 15% more than they issued during the same period last year.
Delray Beach, Florida
September 24, 2015
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