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Toll Brothers Inc (TOL), D.R. Horton, Inc. (DHI), Wells Fargo & Co (WFC): Three Reasons to Be Optimistic About the U.S. Recovery

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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 Inc (NYSE:TOL) and D.R. Horton, Inc. (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 & Co (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.

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