With long-term interest rates eventually turning higher, we expect that money will start to flow from fixed-income investments to stocks.  This should also help to support higher stock prices over the next few years.

The drama over the future of wireless market in Canada seems to be over for now as news that Verizon will buy out the rest of its wireless arm from Vodafone means that it won’t be coming into Canada as the feared ‘4th player.’   Canadian telecom stocks (mainly BCE, Telus and Rogers) rallied on that news and then rallied even further on September 24th, when the government released the list of bidders on the upcoming wireless spectrum auction and saw that no major foreign players would be entering the market.  While the stocks have now recovered most of the losses from the past few months, we don’t see this as a good time to be adding money to the sector.  Higher interest rates have reduced the attractiveness of many dividend paying stocks, including the telecom group.  More importantly though, growth is slowing for the group as fierce deflationary pressures raise the odds that capital spending will need to accelerate to add services/speed in order to limit subscriber churn.  The upshot is that the chronic profit margin squeeze will stay intact and there is little incentive to bottom fish in the telecom services sector in our view.

While there’s no arguing that higher mortgage rates can indeed temper housing activity, very high affordability and pent-up demand suggest that home prices will continue to march upward despite higher rates, supporting confidence, the real economy and stock prices.  The simple principle of economics; supply and demand, does actually work in the long run.  We often need to be reminded of this in financial markets where emotions can take various assets well above or below their longer-term values based on supply and demand.   A recent reminder that the laws of supply and demand have not been revoked is in the U.S. housing market.  The market clearly got overbuilt in the 2005-2007 period as the boom in alternative lending lead to an expansion in home building that was far in excess of what was ultimately required by the market (nearly 2 million homes per year were constructed during the boom, versus annual household formation of around 1.2 million, meaning that a lot of homes were being bought ‘on spec.’).  Prices then collapsed in the 2008 recession and stayed low for a long time due to these excessive inventories.  But housing starts also fell to an annual rate of under 500,000 homes, which allowed the inventories to be run down.  This is all shown in the chart below of the U.S. inventories of new and existing homes (in terms of months of supply).  After rising to over 12 months of supply, the number has come down to a ‘normal’ zone of about 4 months of supply.  Even though mortgage rates have risen recently, housing starts are still running below 1 million per year, meaning that inventories should continue to fall.  As the inventories get tighter we should start to see home prices move higher.Low inventories

The best way to play this improvement is through the homebuilders in the U.S.  While Lennar and KB Homes are our two favourites based on valuation and growth potential, investors can also just buy the U.S. Home Builders ETF (ticker XHB), which contains all the major home builders as well as suppliers to the home industry such as Whirlpool, USG Corp (wallboard) and retailers such as Bed, Bath & Beyond and Home Depot.  While the U.S. banks are also a good way to play the recovery in housing, the major banks face some other pressures in the short-term including fixed income trading losses, a tougher regulatory environment and slower growth in mortgage re-financing.  Although we still like JP Morgan and Citigroup, we reduced positions in both recently, in anticipation of some tougher earnings comparisons in the upcoming third quarter reports.

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