With The Economy Recovering, Are Higher Rates Imminent?

Quietly, under the radar, all signs are pointing to a strong recovery in the housing market. Sales of both previously occupied homes and new homes rose sharply last month, as did building permits. Building permits are up a whopping 22% over the past year.

Mortgage applications are rising. And prices are rising in most markets. We’ve even seen improvement in billings from architects.

You wouldn’t know it from watching the news or from talking to the average American—who remains deeply pessimistic about housing and the economy in general—but we have the makings of a mini-boom in housing that should go a long ways towards stabilizing the U.S. economy.

Remember, in addition to the jobs in construction and finance that a strong housing market creates, there are the spillover effects. A strong housing market makes it easier for Americans to sell their homes and move for a better job opportunity. It’s impossible to calculate with any accuracy, but some portion of our 7.9% unemployment rate is “frictional” unemployment, which means that would-be workers are not able to take available jobs because they are not mobile enough to take them.

What does all of this mean for interest rates—and for a resumption in the bull market in equities?

So much of the recent recover y in home prices has been due to low mortgage rates. Housing is affected by rates the same way that bonds are. Lower interest rates mean higher home prices for a given monthly payment. So, if mortgage rates rise too quickly, they can nip this would-be recovery in the bud.

This is something that bears watching, but for now it doesn’t concern me. I do expect rates to rise from their current lows, but I do not expect them to return to pre-crisis levels any time soon. As Japan has proven, inflation and interest rates can remain subdued for years following a major asset bubble.

It is a simple case of supply and demand. When there is a large supply of money but comparatively little demand for it in the form of loans, the price of money—in this case the interest rate—falls. This was the case for Japan during its two lost decades, and it is the case in America and Europe today. A deleveraging private sector is more than compensating for a spendthrift government to reduce the total amount of debt. Add to this Bernanke’s insistence on keeping quantitative easing measure in effect until we see a real fall in the unemployment rate, and you have a recipe for continued low rates, housing recovery or not.

Where does this leave the stock market?

Worries about higher taxes have hit dividend-paying stocks in the weeks following the election, and I expect tax loss selling by high-net-worth investors to keep a lid on prices for the remainder of 2012.

But in a world of low yields, dividend paying stocks are still going to be the best option for most investors. My favorite dividend-focused ETF is the Vanguard Dividend Appreciation ETF (VIG), which yields a modest 2.11% in dividends. But unlike bond coupon payments, VIG’s payout will rise over time. The ETF’s holdings consist of stocks that have raised their dividend for a minimum of 10 consecutive years—which means they raised them throughout the chaotic years of 2008 to the present. The ETF’s cash payout is up 13% year over year, and I expect continued strong boosts in the years ahead.

Disclosures: Sizemore Capital is long VIG.