Tina Adatia, Fixed Income Strategist: Why are we positive on US housing at the moment?
Scott A. Mather, CIO U.S. Core Strategies: Well, several reasons. I mean, one, the fundamentals and supply/demand are strongly supportive of the housing market at this point in time. We've had underbuilding in this cycle. It's pretty rare to have this extreme amount of underbuilding.
Now, the prior cycle, of course we've had overbuilding, and that was part of the story, an excess supply.
Chart: The chart shows a line (home ownership rate in millions) rising slightly then falling and rising again overlaying a mountain chart (cumulative excess homes built), which rises and falls, from 2000 to 2020. In 2020 home ownership surpasses supply.
We have one measure of excess building. And you see we've been running in a deficit situation and drawing down the amount of homes that are in supply relative to household formation. And so we've been underbuilding for really the last decade, and so we've reached sort of an extreme deficit sort of situation.
And we had pretty consistent falling home ownership rates. They've now begun to, begun to rise a little bit.
And part of the reason for that is affordability, which is another thing that is very supportive of the housing market at this point in time.
Chart: The line graph depicts the PIMCO U.S. housing affordability ratio from 2004 to 2019. The line begins with a dip and then steadily increases, dips again and levels (more affordable period), and then dips and grows near the end of the period.
So mortgage rates are low. Also the employment market has been very solid, and wage gains have gradually picked up in the cycle.
So when we look at it from a supply/demand perspective, as well as from an affordability perspective, there's a lot of positive things to be said about the US housing market.
Tina: And how are you taking advantage of that in your fixed income portfolios?
Scott: We definitely favor mortgage and securitized credit at this point in the cycle, as a good substitute for corporate credit. Part of that is valuation. When we look at spread assets, the mortgage is one that is still under long-term fair value in most, really on a global basis, but particularly in the US.
And here we have a chart that demonstrates that.
Chart: A triple line chart shows the change in valuations for agency MBS from 2009 to 2019. The model rich/cheap vs. swaps shows 3% rich/cheap vs. 3.5% rich/cheap vs. 4% rich cheap valuations move from near convergence to widening spreads to convergence at the end of the time period.
It's a graph of the OAS, or option-adjusted spread history, of agency mortgage-backed securities, which are a large part of the market in the US. And you can see that, you know, we've been on the richer side, but now we've been on the cheap side of where we've been historically over the past decade. And when we combine that with what we think are pretty positive fundamentals, it's particularly an attractive sector.
So for all those reasons, we have an overweight to agency mortgage-backed securities, and we also have an overweight to non-agency mortgage-backed securities, the private-label securities, which we think are also on the cheaper side of, of fair value.
And on a global basis, we're finding more value in securitized credits. So whether it's commercial mortgage-backed securities or residential mortgage-backed securities, it's, it’s pretty universally true when we look throughout the rest of the world as well.
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