The Truth Behind The Housing Market

Overview:

This article is largely a reply to many comments I had on my last article: Trump Euphoria Fades Signaling A Short For Home Builders.

In this article, I showed how the “confidence” surveys that surged after the election are beginning to slip and much of the hard data in housing is rolling over which is making ITB, iShares U.S. Home Construction ETF, and other housing related stocks look like an attractive long-term short (6-12 months). I stick to macro-economics and don’t often select individual companies which is why ITB is the closest proxy I can use.

The only thing strong is the performance of ITB, not the actual housing data. Many look at the housing stocks and then say the housing data is strong because the stocks are doing well. That is the same thing as saying the S&P 500 or SPY, SPDR S&P 500 Trust ETF, is at an all-time high, therefore the economy must be great. It is easy to see the flaw in this logic so rather than argue over the housing market with past performance of stocks and ETFs, I want to lay out some housing data that are simply numbers and facts, not subjective anecdotes on what people feel.

The data I will use is not cherry picked, it is the housing data that is defined as important or “market moving” by Bloomberg in their economic calendar which you can find here.

With all that out of the way, let’s look at the housing data.

Brief Macro Outline:

Before diving into all things housing, I want to touch on a few overall Marco data points that drive most economic activity. This data is also relevant to the housing market but are more overall economic indicators.

I will keep this brief.

Running Macro Data Table for July 2017:This is a running monthly macro-economic data table that I track and publish to my marketplace subscribers.

Of the ~30 high frequency economic data points that I track, only 38% of them have come in better than last month and 46% from six months ago. This right away disputes the claim that the economic data is improving. It is slowing over the last several months as less than half of the data has improved.

Corporate Margins:

Corporate margins are a key indicator to look at because they have a large impact on the profitability of companies. Higher margins equal higher profits and lower margins translate to lower profits.

Margins and profits peak before the recession as indicated by the chart. When margins contract, lower profits cause companies to lay off workers in order to keep earnings growth looking stable. This is why the growth in employment is highly correlated to corporate margins.

Corporate Margins:(Federal Reserve Board of Governors)

The peak in corporate margins is behind us for this cycle which implies that the peak in employment is also behind us.

Employment:

The growth in employment is a slightly lagging indicator because like I mentioned above, employment is typically a reactionary response to profits.

The chart below shows the yellow peaks lining up very close to the yellow peaks in the corporate margin chart.

Nonfarm Payrolls:(BLS)

Growth in employment has been slowing for over two years. As employment growth slows, the growth in total wages earned slows as well. Wages are the driving factor behind all consumption, specifically housing which is why the flow from margins to employment to wages is important.

Nonfarm Payrolls:(BLS)

Wages:

Real aggregate earnings is the most important metric to follow as it measures the growth in real dollars earned for the entire economy. The measure of real aggregate earnings is very closely tied to the growth rate of the economy.

Currently, the 12-month average of real aggregate wage growth is 2.12%, right in line with the growth rate of the economy of about 2%.

Real Aggregate Wages:(BLS)

Wage growth is 2.12% but housing growth is nearly 6% on average over the same time period. How is it that home prices can grow 4x the rate of wages for any considerable period of time? It seems unreasonable to assume that home prices will continue to grow at this rate. The current rate of home price growth is on the same trajectory as the previous housing bubble.

The chart below uses two green lines to show the slope of the increase to be the same today as it was in the early 2000s.

(FHFA)

Many people didn’t see that time period as unsustainable so I guess I shouldn’t think that people would see it this time.

Many at that time suffered the same blind bullishness that they do today without regard for the fact that houses are growing at 4x the pace of wages.

Home prices do not have to outright decline, all they have to do is slow the rate of their acceleration to cause a problem due to the massive leverage involved in the housing market.

Those who are bullish must believe that home prices will continue to grow in the 6% range which to me is simply foolish.

Macro Summary:

With the current standing of the main macro economic factors, (margins, employment, and wages) all past the cycle peak and declining, the bias is downward for the overall economy and that means downward for growth rate of housing.

To reiterate, home prices do not need to decline, they simply need to slow their rate of acceleration to cause a massive blow back in the housing sector. (Think construction jobs, real estate jobs etc. that will have to be cut due to a falling growth rate in the housing market).

No industry keeps the same amount of people if the growth rate of that industry is cut in half.

Now on to housing.

All Things Housing:

The data below is the housing data that is defined as important or “market moving” by Bloomberg in their economic calendar which you can find here. These are the main housing and construction related indicators and are not subjectively selected by me.

Construction Spending:

Construction Spending, a data series published by the Census Bureau, measures “the (dollar) value of construction put in place and is a measure of the value of construction installed or erected at the site during a given period.”

Construction Spending includes:

1. Cost of materials installed or erected.

2. Cost of labor (both by contractors and force account) and a proportionate share of the cost of construction equipment rental.

3. Contractor’s profit.

4. Cost of architectural and engineering work.

5. Miscellaneous overhead and office costs chargeable to the project on the owner’s books.

6. Interest and taxes paid during construction (except for state and locally owned projects).

Spending is broken down mainly into “Total,” “Private” and “Public” (government owned) and within those, “Residential” and “Nonresidential.”

Construction Spending:(Census Bureau)

Construction spending growth has fallen off significantly since 2014 peak and continues to fall over the last several months.

Residential construction spending is more relevant to the prospects in the housing market. That chart is below.

Residential Construction Spending:(Census Bureau)

A similar picture can be seen in the growth of Residential Construction spending. The growth rate is far lower than it was in 2014 and is close to the lowest growth rate in several years.

The most important note is that the trend is lower. Growth in residential construction is trending lower and home prices are trending higher. This is unsustainable.

The long run trend is clearly lower but also he growth in Residential Construction spending is lower than last month and lower than six months ago which makes the short-term trend lower as well.

Housing Starts:

Housing starts are the number of new residential construction projects that have begun during any particular month. The New Residential Construction Report, commonly referred to as “housing starts,” is considered to be a critical indicator of economic strength.

Housing starts had a massive rate of growth in 2013. That growth rate fell off but rebounded from 2015-2016. That growth rate is now rolling over and resuming the longer run down trend from the 2013 peak.

The red line indicates that this most recent move lower has a steeper slope, which is more bearish when looking at decelerating growth rates.

Housing Starts:(Census Bureau)

Again, the growth in Housing starts is at a multi-year low while home prices are at a multi-year high.

Existing Home Sales:

The Existing-Home Sales data measures sales and prices of existing single-family homes for the nation overall, and gives breakdowns for the West, Midwest, South, and Northeast regions of the country. These figures include condos and co-ops, in addition to single-family homes.

This past month’s report on Existing Home Sales showed a decline in the growth rate to just 0.73%. The volume of transactions is really drying up based on the data.

A growth rate of 0.73% is lower than last month, six months ago, and a year ago making the downward trend clear.

Existing Single Family Home Sales:(National Association of Realtors)

As the volume of transactions falls, home prices rise? The median price of Existing Home sales is rising as seen below.

Existing Single Family Median Home Price:(National Association of Realtors)

Once again, fundamentals weaker and prices higher…

Home Prices:

The most recent housing related data point was the well known Case-Shiller Home Price Index.

The S&P CoreLogic Case-Shiller Home Price Indices are the leading measures of U.S. residential real estate prices, tracking changes in the value of residential real estate both nationally as well as in 20 metropolitan regions.

National Home Price Index:(S&P Dow Jones Indices)

What is interesting is that while prices are still rising, when you look at the breadth of the acceleration it appears that the fundamentals may be catching up to the housing market with many cities showing declining growth rates.

Even the National Index has a lower rate of growth than a few months ago which may be a sign that the peak in the growth rate of home prices has happened and the fundamentals of the housing market are remaining true.

National Home Price Index:(S&P Dow Jones Indices)

Below is a table of the growth rate in home prices of the 20 major cities in the country and a comparison to prior periods.

Only 39% of the components showed a better growth rate than last month and 61% from six months ago.

National Home Price Index Table:(S&P Dow Jones Indices)

The breadth of home price appreciation is lower than half and getting weaker.

Home prices always are the last to react to the underlying fundamentals of housing but it appears that the data may be corroborated in the coming months.

A continued decline in the rate of home price growth is what I expect over the next 6-12 months and that should cause the price of housing related stocks to under perform, which is why I view this space as an attractive long-term short.

Bonus: Commercial Real Estate:

Commercial Real Estate prices are on the verge of posting the first year over year decline since 2007 and only the third time in nearly 30 years.

Commercial Real Estate Prices:

(Source: Green Street Advisors Index)

The main culprit for the declines in Commercial Real Estate prices are clearly the retail stores that are going out of business.

A second component that is going to amplify the decline in Commercial Real Estate prices in the year to come and cause a large problem is apartments.

There is a flood of new units coming to market in 2017 and the prices in the main cities are already declining.

(Source: Yardi Matrix, Rent Cafe)

These apartments will be adding a massive amount of supply into a declining apartment rent market.

(Source: ZUMPER)

This set up has the potential to cascade Commercial Real Estate prices which are highly leveraged investments. Many are secured by Fannie Mae into Commercial Mortgage Backed Securities (NYSEARCA:CMBS).

This is an area of the market to keep a close eye on as it poses significant risk to the market.

Takeaway:

The current macro backdrop coupled with the slowing housing data makes ITB and other housing related stocks an attractive long-term short.

I am not concerned with the short term moves but rather getting the longer run trend right. The massive run in the housing stocks is overdone based on the fundamentals. Home prices are beginning to slow which could be the first crack in the housing stocks.

It will take time to play out as it always does but given the data at hand, a slowing of home prices seems inevitable and has already begun in most cities.

A slow down in home price growth will be enough to make the housing space an attractive place to be short relative to the broader market.

Disclosure: I am/we are long TLT, IEF, SPY, GLD, MUB, SLV, SCHD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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