Why we saw a big downward revision in the 4Q13 US economy
The ten-year bond is the basic driver of REITs and homebuilders
Long-term interest rates are priced off the benchmark long-term bond, which is the ten-year Treasury. These days, the ten-year bond reacts to economic data through the Federal Reserve’s asset purchase program, also known as “quantitative easing” (or QE). As a general rule, economic data that shows weakness is bond bullish (positive). However, data that shows strength isn’t necessarily bond bearish (negative).
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Some weaker-than-expected economic data
We had manufacturing reports from the regional Fed banks last week, and pretty much everyone reported weather-driven weakness. The second revision to fourth quarter GDP was large, as it was revised from 3.2% to 2.4%.
Homebuilder earnings and M&A
Toll Brothers (TOL) reported good numbers last week. The homebuilding segment has definitely been a case of two sectors—the luxury sector, which is doing extremely well, and the first-time homebuyer sector, which is getting bombarded by increasing real estate prices, increasing interest rates, and a lousy job market.
We’re starting to see mergers and acquisitions (M&A) activity in the homebuilding space, with two deals. First, Tri Pointe Homes (TPH) is buying Weyerhaeuser’s homebuilding unit, and second, Toll Brothers is buying Shapell. We can attribute much of this to the two-tiered financing market in general. Large companies like those in the homebuilder ETF (XHB) are able to borrow at exceptionally low interest rates and almost have money thrown at them by the Street. Smaller builders, however, are stuck dealing with the banks, and credit is much tighter for them.
Commercial REIT earnings
Recently, we heard from mall REIT heavyweights Simon Property Group (SPG) and General Growth Properties (GGP). Overall, retail sales may have been slightly disappointing, but these mall REITs are reporting strong numbers.
Implications for mortgage REITs
Mortgage REITs, like Annaly (NLY) and American Capital (AGNC), are driven by interest rates. NLY reported earnings and said that it was planning to increase its bet in mortgage-backed securities and increase its leverage. The mortgage REITs have been crushed as the ten-year bond has sold off, but they’ve been trying to form a bottom here. For REITs, it’s all about the Fed’s exit of QE (quantitative easing).
Implications for homebuilders
Last week, we heard from Toll Brothers. It has been able to raise prices, although buyers seem to be hitting their breaking point with price hikes. This probably means the days of increasing gross margins are behind them. While the first-time homebuyer remains on the sidelines, the move-up buyer has been active and has been driving price increases.