The Value of a Home. RCIO Monthly Market Advisor

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1 The following information and opinions are provided courtesy of Wells Fargo Bank N.A RCIO Monthly Market Advisor The Value of a Home JULY 16, 2015 Regional Chief Investment Officers Sean McCarthy, CFA, Southwest Marc Doss, CFA, CA & Nevada John Lynch, Mid-Atlantic Cam Hinds, CFA, Great Lakes Dave Roda, CFA, Southeast Michael Serio, CFA, Mt. Northwest Kei Sasaki, CFA, Northeast In this Monthly Market Advisor: U.S. household formation has grown as the Millennial generation finally leaves home. Home ownership is recovering from its downturn during the Great Recession. The recovery likely will have a positive impact on consumer spending, which accounts for 68 percent of the U.S. economy. Investors can take advantage of these trends by: Including an allocation to real estate investment trusts (REITs); and Tactically overweighting cyclical sectors such as consumer, industrial, and technology stocks in the equity allocation of their portfolios. Housing has been slow to recover from the Great Recession of due to stubbornly high unemployment and a lack of real wage growth. Personal consumption expenditures (PCE) account for about 68 percent of U.S. gross domestic product (GDP) so the health of the U.S. economy is greatly dependent upon the consumer s ability and willingness to spend. Household creation and the wealth effect created by a robust housing market are significant drivers of consumer spending. After roughly six years of a long-drawn-out healing process, the labor markets, wages, and consequently private net worth, have begun to improve, and home ownership across the U.S. is once again on the rise. It is good news, then, that the U.S. economy has seen an increase in household formation. U.S. Commerce Department data shows million occupied households in the first quarter of this year, up from million a year earlier. The data also indicates that most of the 1.5 million new households live in rental apartments, reflecting the financial situation of 88 million Millennials. This generation comprising individuals with ages between 18 and 35, represents 27 percent of the U.S. population and over one-third of the domestic workforce. This is larger than both the Generation Xers and Baby Boomers, each of which represents slightly less than a third of the working population. A greater percentage of this demographic has been attending college compared to prior generations. They have been in school longer, taken on more debt to do so, and delayed marriage decisions. It makes sense that their initial move is from parents homes into more abundant and affordable rentals. 1

2 Chart 1: Household Formation in the U.S. Climbed During 2014 Source: FactSet, 7/2/15 Supporting the view that most households are being formed in rentals, data from May showed that the national homeownership rate has fallen to 63.7 percent, the lowest it has been since It is heartening to note that recent data suggests that the tide of home ownership also may be turning. The Federal Reserve s (Fed) Report on the Economic Well-Being of U.S. Households published in May examined results from an October survey of renters. A remarkable 81 percent of renters indicated they would prefer to own their home if they could afford to do so. The most common reasons for not owning were inability to afford down payment (50 percent) or to qualify for a mortgage (31 percent). This situation likely will improve over time, if, as we anticipate, household incomes continue their rising trend. The Employment Cost Index from the Bureau of Labor Statistics reported that wages and salaries for private industry workers increased 2.8 percent over the past year through the first quarter of Is that enough improvement to spur buying? For some the answer is a resounding yes, and the number will grow as employment and wages continue to improve. Millennials now represent the largest share of the U.S. workforce at 34 percent. More than one-in-eight 18 to 29 year olds in the aforementioned Fed survey indicated last year they were looking to buy a home, and it appears they are beginning to do so. The most recent release of existing home sales reported a 9.2 percent increase compared to the same month last year. May s sales 2

3 growth figure coupled with March s 11.9 percent annualized growth rate are the two strongest months for U.S. home sales seen in nearly two years. Chart 2: National Association of Home Builders/ Wells Fargo Housing Market Index 2015 (Seasonally Adjusted) May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Revised Prelim Housing Market Index Housing Market Index Components Single Family Sales: Present Single Family Sales: Next 6 Months Traffic of Prospective Buyers Source: NAHB/Wells Fargo HMI, 7/2/15 Moreover, first-time home buyers represented almost one-third of existing home sales, up from closer to a quarter a year ago. There is greater demand for new construction as well. This is evident in the National Association of Home Builders/Wells Fargo Housing Market Index reflecting the highest homebuilder confidence since the third quarter of last year. Buyer traffic is at its best level this year with the measures for current and projected single-family home sales at their highest levels since Much like the market for existing homes, builders are seeing first-time home buyers accounting for an increased share of their clients. The initial force from this segment is creating ripple effects up the housing chain and across the economy. What do these trends mean for your portfolio? Sustained improvement in housing fundamentals as well as greater confidence from builders and consumers should help drive continued economic expansion in the U.S. Investors can take advantage of this trend by including an allocation to real estate investment trusts (REITs) that is in line with their investment objectives and risk tolerance. In addition, our recommendation for a higher allocation to U.S. large-cap equities than one would have in a more neutral investing environment is consistent with this constructive outlook. Within domestic equities, we suggest favoring cyclically sensitive sectors such as Consumer Discretionary, Industrials, and Information Technology. Positioning portfolios this way likely will help investors take advantage of a U.S. economy that is already rebounding from early-year weakness. 3

4 Chart 3: 2015 Opportunities in U.S. Equities Source: Bloomberg and Wells Fargo Investment Institute (WFII). Note: 7/3/15. S&P 500 weightings as of 5/31/15. If we take the example of a hypothetical balanced portfolio, we currently recommend an overall 18 percent allocation to U.S. large-cap stocks. Of this, based on shifting your allocation towards what we believe will be better-performing sectors, 46.8 percent should be in the three sectors that we have noted above. Chart 4: Equity Tactical Tilts for a Hypothetical Portfolio Source: WFII, June 2015 Implementing such a tactical shift not only helps you take advantage of potential outperformance in these sectors, it can also help manage risk by maintaining well-diversified equity exposure. 4

5 Conclusion In sum, the number of households in the U.S. continues to rise as Millennials leave home thanks to an improving job market, and first-time home buyers increasingly are taking advantage of the financial benefits of homeownership. Millennials who represent the largest share of the work force now make up a significant percentage of first-time buying demand. This development has strong positive implications for both investment and consumption in the economy. Additional spending in these areas helps bolster expectations for earnings, supporting an overweight recommendation for U.S. large-cap equities with an emphasis on cyclical sectors. Important risk disclosures All investing involves risk including the possible loss of principal. Different investments offer different levels of potential return and market risk. Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. A stock s value may fluctuate in response to general economic and market conditions, the prospects of individual companies and industry sectors. Technology and internet-related stocks, especially of smaller, less-seasoned companies, tend to be more volatile than the overall market. Investing in REITs involves special risks, including the possible illiquidity of the underlying property, credit risk, interest rate fluctuations and the impact of varied economic conditions. Diversification does not guarantee a profit or protect against loss. Disclosures Wells Fargo Wealth Management provides products and services through Wells Fargo Bank, N.A. and its various affiliates and subsidiaries. The information and opinions in this report were prepared by the investment management division within Wells Fargo Wealth Management. Information and opinions have been obtained or derived from sources we consider reliable, but we cannot guarantee their accuracy or completeness. Opinions represent Wells Fargo Wealth Management s opinion as of the date of this report and are for general information purposes only. Wells Fargo Wealth Management does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. This report is not an offer to buy or sell, or a solicitation of an offer to buy or sell the securities or strategies mentioned. The investments discussed or recommended in the presentation may be unsuitable for some investors depending on their specific investment objectives and financial position. Wells Fargo Investment Institute, Inc. is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company. Brokerage products and services are offered through Wells Fargo Advisors. Wells Fargo Advisors is the trade name used by two separate registered broker-dealers: Wells Fargo Advisors, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, non-bank affiliates of Wells Fargo & Company. First Clearing, LLC, Member SIPC, is a registered broker-dealer and non-bank affiliate of Wells Fargo & Company Wells Fargo Bank, N.A. All rights reserved. CAR#

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