Equity Outlook  |  Q4 2019

The case for U.S. housing

The case for U.S. housing

Despite a sometimes turbulent ride for global equity markets in 2019, there is still a lot to like about the U.S. consumer sector. Many retail stores and restaurants, particularly at the low end of the market, have experienced impressive sales growth this year. In August, the Commerce Department reported a sixth straight month of positive growth for retail sales. Unemployment is at an all-time low, and wages have increased. And after a brief downturn, the housing market continues to be a positive force for equity investors, in my view.

A bump in the road for housing

In many respects, the U.S. housing market is still recovering from one of its greatest busts in history. Following the peak of the housing bubble in 2006 and the subsequent market collapse, U.S. home prices declined for six years. In 2012, housing began a remarkable recovery, and it has largely been a pillar of strength for the U.S. economy in the years since.

Housing hit a rough patch late in the third quarter of last year, due to a significant increase in interest rates. For September 2018, there was a 9% year-over-year drop in sales of single-family existing homes and an 8% year-over-year decline in new home sales. I would describe it as a housing recession that lasted approximately eight months. In July 2019, year-over-year U.S. home sales rose more than expected due to lower mortgage rates and the healthy labor market.

The good news: Inventory is tight

The U.S. economy has continued to grow in 2019, and demand for homes remains steady. In my view, we are not building enough new homes. According to recent data, the current inventory of U.S. homes available for sale is well below the long-term average. This can be good news for consumers as it helps to drive up home prices and boost aggregate housing wealth. Also, although their prices have been increasing, homes are still affordable, helped by rising household income.

When housing wealth grows, even homeowners who choose to stay put tend to invest more in home improvement. The solid demand from homeowners for products, services, and supplies bodes well for many stocks in the consumer sector, particularly home improvement retailers and their suppliers.

Despite rising prices, housing remains affordable

Inventory is tight, boosting housing wealth

Which stocks could benefit from housing wealth?

Home Depot (HD)
This home improvement retailer should continue to benefit from the growth in housing wealth. We believe the stock is attractively priced, and the company has a strong management team, generates solid free cash flow, and strategically allocates its capital. Also, this stock, unlike those of many retailers, is somewhat insulated from the "Amazon effect" — the pressure placed on traditional businesses from online competition. We believe Home Depot can withstand this threat due to the specialized nature of its products and the services, which are not conducive to online shopping.

Sherwin-Williams (SHW)
This paint manufacturer is another beneficiary of consumer spending on home improvement. One of this company's strengths, in our view, is its focus on serving the needs of professional painters. Many consider it the "go to" paint supplier for contractors, and Sherwin-Williams has put considerable research and development into tailoring its products, retail stores, and ordering systems to help them. The company is also relatively immune from online competition, delivers high returns on capital, and benefits from the dual profit streams of manufacturing its paint and selling it.

Fortune Brands Home and Security (FBHS)
This residential building products company specializes in cabinets, plumbing, exterior doors, and security systems. It recently entered the outdoor living category with its acquisition of a composite decking company. Fortune Brands is a conglomerate of businesses that benefit from the marketing and distribution channel knowledge of their former parent companies. We believe the stock is very attractively valued, trading at a material discount to its historic average valuation and that of a key competitor, Masco Corporation.

As of 6/30/19, Home Depot represented 1.81% of Putnam Research Fund assets and was not held in Putnam Global Equity Fund. Sherwin Williams represented 0.70% of Putnam Research Fund assets and 1.43% of Putnam Global Equity Fund assets. Fortune Brands represented 0.66% of Putnam Research Fund assets and 1.01% of Putnam Global Equity Fund assets.

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