These 3 Industries Are Set Up for a Potentially Rough 2015
There are some moments in our investing lives where it seems you could just about throw the kitchen sink at the market and it would simply take the hit and smile back. That's pretty much where I see things right now.
Overall, the fundamentals behind the market's rally do make a good bit of sense. The U.S. unemployment rate is at its lowest level since the recession at 6.3%; housing prices are on the mend; consumer credit is rising, which would imply higher levels of spending; low lending rates are fueling home purchases and business expansion; and the manufacturing sector is growing at its fastest pace in years.
But don't take this "market melt-up" to mean everything is perfect with the U.S. economy. The labor force participation rate has been on a steady decline, the median time to find work if you're unemployed isn't falling nearly fast enough, and many companies have turned to cost-cutting and stock repurchases to mask their lack of strong organic growth.
Source: Wikimedia Commons.
All eyes on the Fed
What the Federal Reserve does in the coming months is going to have drastic implications on businesses and consumers going forward. The Fed has already been winding down its economic stimulus known as QE3, which is both a positive sign that the U.S. economy is strong enough to stand on its own two feet again, and a negative for investors in that the free money the Fed has pumped into the economy on a monthly basis is shortly coming to an end.
What investors should really be taking note of is the Federal Open Market Committee's interest-rate forecasts from a little more than a week ago. While its U.S. growth forecast for 2014 was tempered a bit largely because of the effects of the polar vortex rather than any endemic growth concerns, both its 2015 and 2016 median interest rate forecasts rose to 1.125% and 2.4%, respectively. In other words, the days when the Fed is uber-accommodative with lending rates are nearly over.
Investors and consumers knew this day was eventually coming, but that isn't going to make it any easier for some of the most interest rate-sensitive industries. Following what's been an incredible run since 2009, here are three industries that could possibly struggle in a big way in 2015 if lending rates begin to rise as expected.
No industry has proved more interest rate-sensitive than the housing sector. You would think with interest rates hovering near 4%, historically a very low level, that homebuyers would be clamoring at the chance to purchase a home or refinance their mortgage if they haven't done so already. However, that's really not been the case.
Since peaking last May, the Mortgage Bankers Association's loan originations index, a measure of the weekly change in new home loan originations and refinancing activity, is down more than 50%. The culprit was a mere 125-basis-point rise in 30-year mortgage rates from 3.375% to roughly 4.625%. While the move came as a bit of a shock to prospective homebuyers last year, 4.625% would still be low by historical standards, especially considering that it's been more than four years since we've seen a 30-year rate above 5%!
The concern here would be that if consumers are already balking at lending rates in the 4%-4.5% range, then what's going to happen when the federal funds rate rises by close to 100 basis points by the end of 2015 and 30-year mortgage rates adjust up to 5% or perhaps even a bit higher? My suspicion is that home sales are going to grind to a halt.
Thankfully, homebuilders such as Lennar , which just this week reported that its homebuilding gross margin expanded 140 basis points to 25.5% year over year, have been keeping their new construction under control. By reducing supply, homebuilders are hoping to entice buyers by buoying prices and creating a sense of urgency to buy. If there's any homebuilder that can survive a rate increase better than any other in the sector, it's Lennar, but I'd still be skeptical of how long supply controls can boost prices if demand falls through the floor.
For investors brave enough to stick with Ford throughout the recession, you've been greatly rewarded. Ford turnaround specialist and CEO Alan Mulally took the time needed to refocus the company on fuel economy, price, and styling, pushing Ford in a completely different direction. Now the company is a brand-loyalty leader and is a big reason the U.S. market saw 15.6 million vehicles being sold last year.
However, automakers in general, including Ford, could be set up for a disappointing 2015 campaign.
Similar to housing, consumers are fairly sensitive when it comes to minor interest changes in big-ticket items -- cars included. Ford and other automakers have been pushing low APRs as the icing on the cake to get consumers to dive headfirst into a new vehicle. As soon as rates begin to rise, we might kiss the days of 0% APR or 0.9% APR goodbye, retiring an important marketing tool automakers had been using to get traffic into dealerships.
Furthermore, we have to remember that automakers often carry large amounts of debt. These automakers have worked out optimal lending rates for the time being on their debt, but any additional debt to be issued moving forward would probably be at a higher interest rate.
Finally, and perhaps most importantly, the amount being financed by consumers to purchase a car is only growing. As car prices increase, the amount consumers are willing to put down has not, leading to the financing of more debt over longer periods of time. If lending rates begin rising, the monthly cost basis for consumers looking to buy a new or used vehicle could change drastically, adding a tough obstacle for dealerships and automakers to overcome.
Finally, the normally steady utilities sector could be in for a rough campaign if lending rates begin to rise.
Unlike housing and cars, where there's a pretty direct correlation between higher rates causing consumers to be pickier about what they buy, the correlation isn't as front-and-center with utility providers. Yet there are two potentially negative consequences that could push electric utility providers such as Exelon lower.
First, electric utilities often boast a lot of debt, since building out power-generating infrastructure isn't cheap. Even investing in alternative energies such as solar, which will lower businesses' and consumers' long-term costs, usually leads to hefty upfront costs. Exelon, for instance, is currently toting around $20.6 billion in total debt. The good news is that Exelon has done a good job of using low lending rates to lock in favorable interest rates for its existing debt. But similar to the automotive example, any newly issued debt is going to price at a less favorable interest rate for Exelon.
The other factor investors may overlook is that the utility industry in general is sought after because of its steady dividend payments. Exelon's 3.4% yield gives investors a way of racking up sustainable income while also getting the chance to achieve share-price gains in a basic-needs business. However, as lending rates push higher, the rates on bank CDs should also begin to rise, making dividends appear less tempting to some investors. Foolish long-term investors know full well that there's always room for dividends in any investor's portfolio, but a rise in bank CDs could tempt some people to pull money out of the market, especially the utility sector, and cause it to be parked in "safer" investments like CDs.
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The article These 3 Industries Are Set Up for a Potentially Rough 2015 originally appeared on Fool.com.Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. The Motley Fool owns shares of, and recommends Ford. It also recommends Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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