The Homeless Recovery?

July 1, 2010

The Homeless Recovery?...No, we're not referring to some type of improvement in the homeless problem domestically.  Unfortunately with what is happening both in residential real estate and labor markets, that problem probably gets worse before it gets better.  It has been some time since we have looked at the National Association of Home Builders housing index numbers, but believe it's important to do so now.  Especially given the ECRI message of the moment showing us the potential for a proverbial double dip in the macro economy itself.  You already know the recent NAHB monthly reading in the now absence of the homebuyer tax credit was not good at all.  Same deal with month over month new and existing home sales.  But as we have done in the past, looking at the NAHB numbers in isolation is not the key issue.  As we have shown you in prior discussions and is important now, the NAHB data has shown us its own leading tendencies historically that have proven to be important watch points.  Will it be so again?  If housing "double dips", what impact will that have on the macro economy and by extension financial asset prices?  And of course we use the characterization housing double dip very loosely as it assumes a prior period recovery, which itself is very much debatable.  The charts do a lot of the talking here, so we'll try to keep the commentary brief.

First up a look at the actual current impact of housing on the real economy itself, and this is exactly why we say the prior period recovery is a debatable point.  As of the first quarter of this year, residential real estate investment (actual homebuilding activity) as a percentage of GDP checked in at an all time low over the history of the data.  Not exactly a shocker given the unprecedented length of the prior up cycle and current magnitude of available inventory of vacant homes (obviating the need for further building).  As we've said many a time over the years, the three constants in US economic recoveries past have been pent up demand for housing, autos and credit.  At least for now, two of the three remain down for the count with auto sales still far below prior cycle peaks.  This is exactly why the rhythm and tone of government borrowing and spending has been and continues to be so critical at present, having supplanted private sector demand.

But as mentioned, at least historically, housing (the NAHB index) has been a leading indicator for key headline macro economic watch points as we will detail in the charts below.  And importantly, the NAHB index has led many a perceptually important headline macro economic stat at cycle lows and highs, making it pretty darn important in our eyes.  Moreover, as we'll show you in a minute, NAHB directional movement has also been highly directionally correlated with the rate of change movement in equities over time.  First the very simple relationship between the NAHB index and consumer confidence immediately below.  To this day the directional correlation and leading tendency of the NAHB numbers remains fully intact.  As is clear, the NAHB index led the turn upward in consumer confidence after the 1990 and 2001 recessions, and at least so far likewise in the current.  Same deal at cycle peaks seen in the late 1980's, 1999 and late 2006.  This chart we put together just before the June CC numbers hit the tape and we've left it untouched just to show that the NAHB foretold the perceptually large decline for the month.  Right on cue.

Who knows, maybe the recent monthly drop in the NAHB index is a one off.  But if the weakness continues, it would imply a southern turn in consumer confidence in the months ahead.  We'll just have to see what happens.

Importantly, the NAHB index has been incredibly highly correlated with the year over year change in real personal consumption expenditures over time.  Consumption, of course, being critical to the US economy.  Bythe way, importantly in the GDP revision last week, one of the largest downside revisions was seen in personal consumption.  The following chart is visual corroboration of this fact.  And again, the leading tendencies of the NAHB index are evident, albeit lead times have been very short.  The current cycle is the anomaly so far in the history of the data.  Is the perceptual "wealth effect" of housing on household attitudes and ultimate behavior in terms of consumption now changed?  First, the PCE deflator used to calculate "real" personal consumption is incredibly low relative to historical context, helping to support a higher PCE rate of change number at present.  Secondly, we know government support of personal income via transfer payments has been historic, again helping to support consumption for now.  Do these two factors account for the anomaly in the relationship below and are they sustainable even in the face of another potential downturn in housing?  Unless housing has now become relatively meaningless to the tone and rhythm of the domestic economy, we'd sure as heck expect the two data points below to converge at some point.  We'll take it one step at a time as the cycle continues.

Very quickly, it has also been true that directional change in personal consumption and consumer confidence have likewise been very highly correlated over time.  Historically, the rate of change in consumption has led confidence readings.  But as we saw above, housing led consumption.  Again, the noticeable patterns of the current cycle are the divergence points with historical rhythm.  We're either looking at a changed domestic economy relative to the last quarter century, or some type of reconciliation lies ahead as either housing gets a lot better, or the rate of change in consumption moderates.

We know that in the current recovery environment manufacturing has been a highlight bright spot.  In fact when we look across economic cycles past, one of the key differentiation points of cycle specific economic character has been either consumer or business investment economic leadership, and sometimes both.  Same deal goes for economic contractions - either consumer led or business investment led have been key character points.  So, does the economic cycle rhythm of housing coincide with that of production (business investment)?  Turns out in rough form it does.  The next chart looks at the NAHB numbers alongside the year over year change in industrial production.  One more time, in cycles past housing has led cycle peaks and troughs in industrial production.

To our point above, what we are seeing at present is a bit of a revival in business spending.  But as we have discussed in recent missives, the capital spending revival so far is growing incrementally, yet muted relative to historical context as capacity utilization numbers remain just up from historic lows.  The high single digit annual rate of change growth you see in industrial production is more the result of comparisons against prior year Armageddon than not for now.  This will moderate ahead, but it is fair to say capital spending is at least moving in the right direction.  Important question looking ahead being, can corporate capital spending alone continue to support macro recovery without housing at least at some point playing a meaningful role?  Or maybe more correctly, can business spending more than offset the boat anchor drag housing has become in the current cycle?  A certain level of capital spending is mandatory in any cycle simply to replace worn out equipment.  An extension of that spending cycle will require a meaningful level of private sector demand.  And certainly part of that private sector demand is housing related/influenced.  Bottom line?  Once again the directional dichotomy above is an anomaly.  How does this reconcile is the important question for the economy and financial markets ahead.

One more current cycle anomaly?  Why not, right?  As we stated earlier, the constant in US economic recoveries past has been pent up demand for housing, autos and credit.  The following tends to validate that observation.  What has skewed the historic relationship in the current cycle?  Unlike housing, the auto industry does not have historic excess inventory to work off.  Moreover, as has also been true to a point with housing, government subsidies have helped hold up auto sales in the last year.  Finally the rate of change rebound in auto sales must be viewed relative to the prior period rate of change collapse in autos sold.  But for now the current divergence with historic experience remains unresolved.  Can the US experience a sustainable homeless economic recovery?  It's the sustainability point that appears to be the key question as we look at present cycle divergences.

Finally the relationship of housing and employment.  One that appears self obvious.  One more time, just look at the lead and lag relationship historically between the two.  In past cycles housing has led at peaks and troughs.  Of course certainly a factor making the rate of change in payrolls look better than is actually the sustainable case at present is the influence of census hiring over the last few months.  Once that influence washes through we'll see true payroll trends once again.  It's very hard to make a case for a true housing recovery absent meaningful job growth.  And at least so far, the housing industry is not anticipating a significant change in labor market fundamentals, as has indeed been the case in prior cycles.

That's it for reviewing the linkage between the NAHB index and key headline economic stats.  We know you get the point by now.  The divergences of the current cycle are nothing short of glaring.  But in summation the key question becomes, are these more than noticeable divergences meaningful both to the forward trajectory of the real US economy and importantly to financial market outcomes?  As we have harped on for years now, globalization changes everything.  The US domestic housing cycle could theoretically have much less impact on domestic US macro economic outcomes in a more globalized economy than has ever been the case in prior cycles.  That's a clear possibility.  So maybe the anomalies seen above speak to secular change occurring right before our eyes in the current cycle.  As we see it, it's just a bit too early to bet on secular change with precious investment capital.  We'll see what happens ahead, but our conclusion for now is that a second downturn in housing would very much increase the odds of a macro US double dip given the linkages more than apparent in the relationships we have reviewed.  If the NAHB numbers remain soft AND the ECRI WLI continues to deteriorate, the odds of a US double dip will rise very meaningfully, ultimately toward certainty.  You know we'll keep you informed.

Betting Against The House?...We promised you above we'd quickly discuss the historic relationship between housing and equities.  To be honest, you do not need lengthy discussion as the visual below tells the story quite succinctly, no?  We're looking at the NAHB numbers themselves alongside the very simple price only year over year change in the S&P 500.  You can see the historic directional correlation and the current divergence relative to historic rhythm.  One more time at the risk of annoyance, can we experience a continued homeless economic expansion and continued cyclical equity bull?  Or will the price rhythm of equities and housing numbers meet up ahead as has been the case for the last quarter century?  And if that meeting is to take place, then how (equities rate of change decline or NAHB acceleration) and where will that happen?

Contrary Investor

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