3 Reasons to Be Optimistic About the U.S. Recovery

Jerome Powell thinks there are three major reasons to be optimistic about the U.S. economic recovery. Yet we've watched the S&P 500 fall almost 5% from its peak over the past month, only to recover slightly. Is he just plain wrong?

Powell, a Federal Reserve governor, during a speech in June at the Bipartisan Policy Center in Washington D.C. cited the reasons for optimism: an improving housing market, a better-capitalized financial system, and gains in household and business spending. Let's see whether the data from those three areas gives us reasons for optimism or not.

The housing market
The housing market bubble and accompanying collapse was one of the biggest factors contributing to the recession we all endured. Now, the housing industry is slowly clawing its way back to health, as seen in the chart below:

Source: Census Bureau.

Housing starts represent new home construction. While we're still well below the levels we saw 15 years ago, housing starts in July 2013 were 87% above April 2009's low. That represents an annual growth rate of over 15.5%, even including the minor dip seen in the second quarter of this year.

With home construction up -- and projected to keep rising, according to the National Association of Home Builders -- Fools should monitor builders like Toll Brothers (NYSE: TOL  ) and D.R. Horton (NYSE: DHI  ) , whose prices generally follow the same trend of housing starts.

Yet the housing market does not consist only of new homes being built. It also involves new mortgages to finance the purchase of both new and existing homes:

Quarter

Mortgage Originations (in billions)

Q1 2012

$373

Q2 2012

$395

Q3 2012

$471

Q4 2012

$511

Q1 2013

$482

Q2 2013

$494

Q3 2013 (Proj.)

$369

Q4 2013 (Proj.)

$247

Q1 2014 (Proj.)

$251

Q2 2014 (Proj.)

$283

Q3 2014 (Proj.)

$290

Q4 2014 (Proj.)

$267

Source: Mortgage Bankers Association.

The picture there certainly looks much less rosy. The coming months' projections remain well below the 20-year average of $466 billion in originations per quarter. In addition, mortgage rates are rising, which almost always leads to fewer originations.

However, it is vitally important to note that mortgage originations encompass both those made for purchasing and those made for refinancing. And when you see the mortgage business broken out into its different segments, you get a much better idea of where things have been -- and where they're going.

Source: St. Louis Federal Reserve and Mortgage Bankers Association.

As interest rates rise -- that's the red line -- fewer people are refinancing existing mortgages on their current homes -- the green columns. Those refinancings previously drove a lot of the gains in the mortgage business. But even as they fall off, more people are getting brand-new mortgages to buy homes -- the light blue columns. That kind of demand depends far less on interest rate changes than refinancings do. If anything, the actual housing market (when considering homes being bought and sold) looks much better than we would have previously believed.

This will assuredly hurt banks like Wells Fargo (NYSE: WFC  ) . The company announced two weeks ago that as a result of the expected decline in refinancing, it would lay off some 2,300 employees in its mortgage origination business, which wrote over $112 billion in mortgages last quarter.

While Wells Fargo and other banks like it rode the refinancing boom for quite some time, rising rates have caused that industry to come to an expected standstill. However this does not discredit Fed Gov. Powell's suggestion that the recovering housing market will help the U.S. economy.

Homes purchased and homes built both have greater economic impacts than those refinanced. For example, last year, Freddie Mac estimated that a borrower would save just $2,900 a year after they refinanced their mortgage. But the National Association of Home Builders estimated that for every 100 homes built, the local economy around those homes gains $21.1 million -- an economic impact more than 70 times larger than the same amount of refinancings.

Better capitalized financial system
During the financial crisis, too many banks didn't have enough capital to insulate themselves from the various losses the meltdown triggered. Banks typically lend out more money than the cash they have on hand. In good economic times, this isn't a problem, since they still have enough hard cash on hand to meet their daily needs. But when an economy sours, and the loans the banks make start to go bad, they need more cash to cover those losses. If the ratio of what they've lent to what they actually have is too big, the banks risk going belly-up.

While Powell stated that the financial system had improved the capital cushion that protects it from such losses, we also need to see how that improvement has trended:

Source: New York Federal Reserve.

As you can see in the chart above, Powell was absolutely correct. Banks have done a great job of reducing their risky assets in relation to their total assets, while boosting their capital to defend against any losses that may still occur. We have seen a spike in risk-weighted assets and a decline in capital at the beginning of this year, which will be important to monitor in the future. But banks nonetheless now sport capital ratios 50% higher than their lows of 2007.

Surprisingly, the Tier 1 capital ratios of the four largest commercial banks in the United States have also dipped from the peaks they reached last year:

Company

Q2 2013

Q1 2013

Q4 2012

Q3 2012

Q2 2012

Bank of America (NYSE: BAC  )

12.2%

12.2%

12.9%

13.6%

13.8%

Citigroup (NYSE: C  )

13.3%

13.1%

14.1%

13.9%

14.5%

JPMorgan Chase

11.6%

11.6%

12.6%

11.9%

11.3%

Wells Fargo (NYSE: WFC  )

12.1%

11.8%

11.8%

11.5%

11.7%

Source: Company Earnings Reports.

Bank of America and Citi have higher Tier 1 ratios than their more highly regarded peers JPMorgan and Wells Fargo . But B of A and Citi's ratios have fallen since last year, while JPMorgan and Wells Fargo's have risen. It's clear the banks are better capitalized than they once were; however, their trend of lower ratios certainly bears watching.

That said, the banks remain well above the baseline 6% that regulators require. And generally, the more capital banks hold, the less in returns they can generate. Thus, diligent investors should keep a close eye on lower capital ratios to make sure banks strike the right balance between maximum profitability and safety.

Gains in household and business spending
Lastly, Powell noted the improvements in both household (personal) and business spending as the final reasons for optimism in the economy. While their growth has slowed down since the immediate recovery from the recession, both personal consumption and business sales (trade sales and shipments) are now 6% above their Q2 2007 levels.

Source: Bureau of Economic Analysis and US Census Bureau.

In short, Powell was correct. While there may always be unknown troubles lurking, investors should take heart. Despite temporary fluctuations, the long term outlook of the United States is certainly improving. 

And although both investors and pundits alike are skeptical about future growth -- they shouldn't be. Many global regions are still stuck in neutral, and their resurgence could result in windfall profits for select companies. A recent Motley Fool report, "3 Strong Buys for a Global Economic Recovery," outlines three companies that could take off when the global economy gains steam like Powell and the data above proved. Click here to read the full report!


Read/Post Comments (6) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 15, 2013, at 2:07 PM, plange01 wrote:

    until obama is replaced with a president there will be no recovery!

  • Report this Comment On September 15, 2013, at 2:59 PM, bamissfa wrote:

    another ignorant obamasskissing article.

    why don't you interview some real people and stop looking at fake numbers

    the nation can't continue to spend MORE than we take in and make it.

    taxes are too high

    too many damaging regulations.

    obamacare is already killing jobs and

    killing insurance companies, medical providers

    meaning obama's economy the government is too damn big. He has added more than 260,000 federal government positions during the worst recession since the Great Depressions.

    He should have cut the federal government by that many jobs via attrition; when people quit not replace, when people retire, not replaced, maternity leave, not replaced etc. Die, not replaced. Disabled not replaced.

  • Report this Comment On September 15, 2013, at 2:59 PM, 5x8sparky wrote:

    The economy is not in a recovery (but a slow dive) and WILL NOT be in a recovery till the spend thrift ways of Washington are STOPPED COLD!!!!! That goes for all of them!! DEMS, REPUBS, TEA PARTY, all of them ... It amazes me and is sad how most U.S. citizens believe all the propaganda their government feeds them about things... The Dollar has dropped 14% since May of 2008, that's a big warning flag!!! Banks and major/small cities nation wide are going into bankruptcy monthly almost, we're sending money WE DON"T have to other countries which is adding up, plus the $100-150 million dollars daily that the U.S. spends on freebies and puts into their own pockets or towards worthless pork items and we're about to send money to Syerian rebels, full of known terrorists!!! GREAT!!! MONEY WE DON'T HAVE FOLKS!!! WAKE UP!!! The overlooked, simplest economics and finance will tell you we're infact a runaway train going down hill towards a 10,000 foot drop off with no bridge and half way there... People, you have EYES!, OPEN THEM, you have EARS!!, LISTEN!!! we are headed for finacial and economic collapse worse than the 1920's MUCH worse... The treasury keeps printing money it DOES NOT HAVE, that's one very BIG MISTAKE... Germany wants their gold out of our reserve, yet our gov't says it's lost, China is starting to use their currancey as well as S. Korea and 15 other nations.. Why? they see the serious mismanagement in our Government and want NO part of the impending Collapse...I'll give it 18 months... Remember today because its' going to get real bad, REAL soon.. IT's already in motion, We are going to pay dearly for our gov'ts sins... It happened in Brittion, and 10 other countries in history and eveidently we didnt learn or are a bunch of chickens and can't stand up and fight after all... We can't stop this from happening, it's to little to late, but we can lessen the blow, a little...

    Take care all.

  • Report this Comment On September 15, 2013, at 4:32 PM, IpleadThe2nd wrote:

    5x8sparky, you are sorely mistaken. Government thrift is not even close to being the problem. For one thing the government is nothing close to being a spend thrift. If it were we would be much better off. I can't believe that you believe what you are saying is true.

    One trillion in deficit spending is being too thrifty. are you insane? You got the rest of it right, we are in for a proverbial 100mph train wreck, your solution is totally dumb and you are not educated correctly in economics. The system has to reset and all the unproductive leeches have to be shed. we have to go thru a depression/ recession.

  • Report this Comment On September 16, 2013, at 2:36 AM, shineridge wrote:

    There is NO STINKING "recovery" !!!!!!!!! The ONLY thing that has recovered is Fraud Street, and the market is RIGGED. MANIPULATED. The market is total BS. The actual economy is sliding into DEPRESION. Unemployment at 20%, only about 47% of US adults working full time !! Most new jobs created so far this year are PART time, LOW wage jobs. Certainly not jobs one can raise a family on. The so-called housing "recovery" is also balony. MANY of the homes being bought recently have been bought by FOREIGN interests, as speculators. Foreignors buying homes to RENT or re-sell at a profit. This game will NOT last. The LOUSY BANKSTERS have receiverd FREE money (QE), which does NOTHING for Main Street. Regarding personal spending, I've been reading that is DOWN, not up. Retailers have been hurting, NOT celebrating !!!! We are headed for the GREATEST Depression !!!!!

  • Report this Comment On September 21, 2013, at 8:59 AM, mamal11 wrote:

    @IpleadThe2nd

    I have been saying the same for years---the only cure for USA economics would be a reset via depression-like financial crisis. We are very close already and I believe that is why some government "economic recovery" experts are saying we are seeing signs of improvement; it xan hardly get worse! The telling figures are low-paying jobs (service industry) are becoming higher percentage of all jobs being filled as unemployment figures "improve". It's not "improvement" when citizens are earning 1/3rd less...

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