Monday Musings: August 24, 2020

Aug 24, 2020

   |  

Public Trust Credit Team
Share on twitter
Share on linkedin
Share on facebook
Share on email

Fueled by extremely low interest rates, housing market is booming

After being essentially shut down in the spring, the housing market is seeing an extraordinary rebound. According to the National Association of Realtors, existing home sales surged by an impressive 24.7% month-over-month in July. This marks both the strongest monthly gain since the survey began in 1968 and the second consecutive month with a growth rate in excess of 20%. Buyers have been eager to benefit from very low mortgage rates with many reportedly looking for a lifestyle change as a result of the pandemic. First-time buyers accounted for 34% of July sales including a large share of millennials entering the market. The increase in demand combined with the low inventory of available homes prompted the median home price to hit an all-time high of $304,100, up 8.5% year-over-year. However, the outlook remains cloudy as the lack of inventory and high prices are hurdles that limit prospective buyers’ choices. In addition, elevated jobless claims and economic uncertainty raise questions around the sustainability of the strong housing demand.
 
Positively for home buyers, interest rates are likely to remain low for a while thanks to the accommodative monetary policy from the Federal Reserve (Fed). On Thursday, Fed Chairman Jerome Powell is expected to make a speech focused on the central bank’s monetary policy framework review as part of this year’s Jackson Hole symposium. Many market participants expect the adoption of average inflation targeting with an objective of 2% that would accommodate for an overshoot of inflation after a prolonged period of below-target levels. The Fed has already pledged it will hold rates near zero until both its inflation and employment targets are hit.

Highly levered companies bring risk to growth rebound

According to a recent analysis by Bloomberg, both investment grade (IG) and junk-rated companies have inflated their balance sheets to levels not seen since 1996. The average total leverage (total debt/EBITDA) for IG companies has reached ~3.5x and high-yield companies reached ~5.5x, higher than it has been in 24 years. The binge in corporate debt comes from two areas. First, companies had become highly leveraged since the financial crisis as low interest rates made borrowing cheap. Second, instead of deleveraging, the COVID-19 pandemic hit and ushered in a global recession, forcing companies to issue debt to bolster reserves and liquidity as well as keeping operations moving. As a result, issuance through July has already exceeded last year’s full-year number, and the first half of the year was one of the fastest periods of issuance in U.S. history. Recessions also typically prompt declines in EBITDA, the denominator of the leverage equation, which inflates the ratio in the short-term until financial performance recovers.
 
High leverage has meaningful impacts on economic growth and the business cycle. As companies increase their debt load, more and more of their cash flow must be used to pay debt meaning less cash flow is available for reinvestment. As we move out of the likely trough of the recession, corporations’ balance sheets present a material risk to the economic rebound as companies will have to spend more on debt service and less on investments.
All comments and discussion presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses.

Similar Articles

Monday Musings: September 8, 2020

This week we share our thoughts on the increasing U.S. Federal deficit and record demand in the U.S. residential market fueled by low interest rates.

Stay in the loop

 Sign up to receive perspectives on markets, investment strategies, and economic outlook advice.