We are releasing this commentary from our annual Maine gathering. Many writers here will report on this event so we will defer to those professional journalists.
For us the group discussion ranges globally and widely from Brexit to Japan's policy, to China economics to North Korea to oil, to the Fed and, yes, to American politics. The good news is that the Weather and fishing are cooperating.
Now to a market oriented comment.
Longer-time clients know that US ETF portfolio construction at Cumberland has benefited from a strategic decision in favor of a prolonged housing recovery cycle. We also favor the consumer discretionary sector since housing is a component part of it.
The consumer discretionary sector is now our largest sector overweight. The previous largest sector overweight was utilities. That position was recently sold, and profits on that sector were realized for our clients. Cumberland uses three ETFs to achieve portfolio balance and continues to hold all three.
We expect this very long housing recovery cycle to last several more years. Low interest rates mean cheap mortgage financing. Federal government political dysfunction has kept the GSEs in limbo since the financial crisis eight years ago. Low interest rates also mean that the various state housing finance agencies are able to facilitate mortgages through cheap financing obtained in the municipal bond market. Cumberland-managed bond accounts have taken positions to benefit on the fixed-income side of asset allocation.
So, what's the problem?
For the investor class, there is none at the moment. A future issue will be when to sell and redeploy; but currently, the winds sustaining the housing recovery are at the back of the investor, and low rates strongly favor those house-buying borrowers who can pass credit tests.
But there is a strategic problem to think about, one that applies to the analysis of the employment characteristics of the US and other countries. That problem has been articulated by Luc Laeven and Alexander Popov, economists in the research department of the European Central Bank. Their working paper No. 1892/April 2016 is entitled "A lost generation? Education decisions and employment outcomes during the U.S. Housing boom-bust cycles of the 2000s."
Their research found that "in MSAs [metropolitan statistical areas] which experienced large increases in house prices between 2001 and 2006, young adults were substantially more likely to forego a higher education and join the workforce, lowering skill formation." That led to another finding that "during the bust years, the young, especially those without higher education, were more likely to be unemployed in areas which experienced higher declines in house prices."
This is not just an American problem. There is evidence that similar housing versus education trade-offs are occurring in other countries with house price boom-bust cycles. Spain and Ireland are cited by the authors as examples.
The authors also note how rising house prices improve parents' ability to fund their children's educations, while falling prices diminish that ability - just as less-skilled, housing-boom-related jobs dry up and unemployed and unskilled young people recognize the value of pursuing further education to learn marketable skills.
The paper cites other research about a housing boom's adding to marital stability and reproductive rates. The list of research papers cited by the authors is helpful to a serious reader.
Such research is also helpful to investors and practitioners in financial markets. It helps explain the slow recovery in employment and wages. Those with higher education levels are paid more and get jobs more quickly. Foregoing higher education to take advantage of boom-condition wages sets the stage for weaker employment and wages during the bust and in the early stage of recovery.
From the authors' statistics we can estimate some of the recovery potential in the US, and we can look at data subsets for specific MSAs. A steady, gradual, nationally distributed recovery is the most desirable outcome in terms of achieving balance, improving skills, and generating higher incomes.
Will we see such an outcome in the current cycle? History is not propitious here. The risk of a repeating boom-bust seems to be rising. Policy makers may need to incorporate the housing boom-education trade-off into their deliberations as they consider employment conditions as well as very low interest rates.
Nobody ever said central bank policy is easy. Not all effects are intended. High subsidies to housing raise home prices but may also result in adverse consequences that are not readily visible at the time the subsidies are granted.
For now, Cumberland remains overweight the housing sector. Our primary task is to invest for our clients' benefit. An associated task is to observe strategic changes and seek explanations for them. We thank the ECB researchers for adding to that discussion.