No housing market bubble

The worst you can say about the US housing market is that home prices appear to be consolidating after   almost four years of gains. There are few if any signs of a housing bubble waiting to pop, or a mismatch between housing supply and demand. Prices are no longer rising by 5-10% year, to be sure; instead they are rising only 2-3% per year. Nevertheless, housing construction is proceeding at a fairly modest pace, from an historical perspective, and new home sales are increasing. Mortgage rates remain at historically low levels, and housing in general is affordable. 

Chart #1

Chart #1 reminds us that the health of the housing market is closely tied to the health of the broader economy. With one exception—the mini-recession of 2001—a significant downturn in housing starts preceded every recession in the past 50 years. The current level of housing starts is weak by historical standards (40% below the peak of early 2006), but remains far below levels that have been associated with housing busts in the past.

Chart #2

Chart #2 compares a survey of builder sentiment with the level of starts. Not surprisingly, sentiment tends to lead starts. Builder sentiment today remains quite optimistic, and they are the ones closest to the action on the ground. So I would expect to see starts register further gains in the future. Labor shortages likely explain why starts are not more robust. And, it's likely that the prevailing mood of caution in the country and the markets which I've observed for years has contributed to keep the housing market sane. 

Chart #3

Chart #3 shows the supply of unsold homes, which has been very low for a number of years. The supply of unsold homes began rising in 2005, and the housing market peaked (in price and in housing starts) in early 2006. Lax lending standards (negative amortization loans, no doc loans, inverse floaters, zero down payments) and a surge in housing starts created a huge oversupply of homes and an artificially strong demand for homes that was unsustainable. There are no such signs today.

Chart #4

Chart #5

Chart #4 shows the broadest and arguably the best measure of US housing prices. Case-Shiller methodology focuses on repeat sales and covers a large portion of the country. Housing prices today are about 6% above their 2006 high, but on an inflation-adjusted basis, prices are still 12% below their 2006 highs. As Chart #4 also suggests, the real price of homes tends to rise modestly over time, due to the increasingly-larger size of houses and rising real incomes. Chart #5 simply shows the year over year increase in nominal prices. The latest datapoint in Chart #5 shows national home prices up 3.2% in the year ending July. The Case Shiller index for the 20 largest metropolitan areas shows a gain of only 2% in the past year.

Chart #6

Chart #6 shows 30-year fixed mortgage rates, which today are running around 4%, well below the ~6% rates that prevailed in 2006 when the housing market peaked. Prices are only modestly higher today than they were in 2006, but borrowing costs have plunged.

Chart #7

At today's prices and mortgage rates, homes are much more affordable than they were in 2006 (see Chart #7). 

Chart #8

Not surprisingly, new home sales (see Chart #8) are still in an uptrend, and still far below the boom-time levels of the mid-2000s. There is plenty of room to run.

Chart #9

Chart #9 shows an index of new mortgage purchases (i.e., mortgages taken out for new purchases, not for refinancing purposes). Mortgage rates have averaged around 4% during the period shown in this chart, and new buyers have been entering the market all along. 

Chart #10

Chart #10 reminds us that consumer confidence is rather strong, and that adds to the body of evidence (affordable prices, no shortage of new buyers, no oversupply of homes) suggesting that the outlook for the housing market is healthy.

Weak housing starts misleading

May housing starts were much weaker than expected (1092K vs 1220K) and on the surface suggest that the housing boom that started back in 2011 has run its course. However, continued gains in the prices of homebuilders' stocks suggests that the May print was an outlier, driven mainly by weak multi-family starts, and that there is a rotation underway from multi-family to single-family home construction that continues to be strong. Calculated Risk has more details.

The chart above compares starts to an index of homebuilders' sentiment. Sentiment among those closest to the housing market continues to be healthy, even though starts have been roughly flat for the past two years. Homebuilders see things improving, not stagnating as starts would suggest.

The stock market appears to agree. As the chart above shows, the stocks of homebuilders continue to rise in price. This confirms the sentiment index referenced above.

The chart above compares housing starts (white line) to the index of homebuilders' stock prices (orange). The two are highly correlated, and it appears that the index of stock prices leads housing starts by at least several months. Note that the orange line turned down six months prior to the early '06 downturn in starts, and in 2009 it turned up significantly almost a year before starts did.

At the very least this suggests that it would be premature to conclude that the recent weakness in reported housing starts marks the end of the housing construction boom.

Mortgage, housing update

August housing starts were somewhat weaker than expected (571K vs. 590K), but building permits (which point to future housing starts were a bit stronger than expected (620K vs. 590K), so on balance there's no news here. The larger story is told in the charts above. Housing starts have been bouncing along the bottom of their worst nightmare collapse, and this has been going on for over two and a half years. One chapter of the big story is that housing starts have hit bottom; if they were going to go lower, they would have done so by now. The other chapter is that housing starts are going to have to increase by leaps and bounds over the next several years, if only just to catch up to the demands of a growing population.

The longer starts remain at current levels, in fact, the higher the probability that we could be experiencing a general housing shortage within a few years, since the rate of family formations is running well above the current level of starts. That future housing shortage might collide with an abundance of money (if the Fed is slow to mop up the massive amounts of excess bank reserves it has created) to produce another major rise in housing prices. We can't know the timing of the next upturn in the housing cycle, but increasingly, the question is not whether housing prices will rise, but by how much.

When you can borrow at historically low, long-term fixed rates of 4-4.5% to buy into what could be an impressive runup in housing prices, it matters little whether prices have reached their lows or whether they might drift somewhat lower before heading higher.

Residential construction still in a bottoming formation

August housing starts came in a bit higher than expected, and remain consistent with a view that residential construction bottomed in the second quarter of last year, but has since made little progress. (Housing starts are the green line in the above chart.) Always on the lookout for market-based indicators that may lead the numbers put out by government agencies, I note that the Bloomberg index of 17 major homebuilder stocks (red line in the above chart) may fit the bill. It bottomed in the first quarter of last year and has spent about 18 months consolidating. It also predicted the modest slump in housing starts in May-July, and the modest upturn in August. Millions of investors on the ground and crunching numbers may prove better at divining the course of the housing industry than the folks at the U.S. Census Bureau who put out the housing starts number each month.

At the very least, I would venture to say that with housing starts and homebuilders' stocks failing to reach new lows after hitting bottom well over a year ago, one can say with some degree of confidence that we have seen the worst of the housing recession. More and more the issue becomes the timing and the strength of the recovery.

UPDATE: Here is a long-term chart of housing starts. Note how the past two years have seen the most severe drop in residential construction in recorded history, and the weakness has persisted far longer than in any prior recession. The good news is that once the excess inventory of homes is depleted, the rebound in construction—which does not appear imminent, but should be starting within the next 6-9 months—should be fairly dramatic.

Housing starts are truly impressive

For the past several months, the news from the residential construction sector of the economy has been truly impressive, greatly exceeding forecasts. Only one caveat: building activity in the winter months is typically depressed, so seasonal adjustment factors are large and that can turn a modest increase in actual starts into something bigger than it actually is. Winter weather has been milder than usual, so we need to take the recent data with a grain of salt. Regardless, the outlook for residential construction looks impressive, especially when coupled with the fact that mortgage rates are at or near all-time lows and households' finances have never been so healthy.

Chart #1

Chart #1 may be the most economically bullish chart in my collection. It compares actual housing starts to a measure of homebuilder sentiment. Sentiment has been a good leading indicator of starts, and starts in recent months look to have responded to a dramatic increase in sentiment that began about a year ago. Both now point to a robust environment for residential construction activity which in turn could help power the economy to new heights.
 

Chart #2

Chart #2 shows the history of housing starts going back to the late 60s. The residential construction sector is still recovering from the bursting of the housing bubble in the late 00s, and there looks to be plenty of upside potential left.

Chart #3

Chart #3 shows residential building permits, which essentially predict future housing starts by several months. This chart reinforces the message of the first two: we are in the midst of a burst of new activity in the residential construction sector after several years of meager gains.

Chart #4

Chart #4 shows 30-yr fixed mortgage rates for conforming and jumbo loans. Both are at historically low levels. The world's seemingly insatiable desire for 10-yr Treasuries (which I featured in Chart #7 of my previous post) provides an ample source of funds for mortgage lending. There's every reason to believe that financial market conditions will support continued growth in housing activity.

Chart #5

Chart #5 shows that the delinquency rate for home mortgages has never been as low as it is today.

Chart #6

The message of Charts #5, #6, and #7 is powerful: households are in great shape financially. Delinquency rates are at historic lows for all types of loans, and households' financial burdens are also at historic lows.  

Chart #7

So much winning! Trump has a strong housing wind at his back as the November elections approach.

Housing recovery continues

3 months' worth of data released today show that while the housing market took a pause in the Fall, activity continues to push higher.

The NAHB survey of builders' sentiment continues to be a good leading indicator of housing starts, and suggests that housing starts will continue to work their way higher. One caveat: data can be choppy this time of the year, since seasonal adjustment factors are large.

Building permits have been less volatile than starts in recent months, but now appear to have provided good guidance, pointing to a continued rise in starts. From a long-term perspective, permits and starts have only recovered to levels that in the past were symptomatic of recessions. In my view, that only makes stronger the case for continued improvement in the housing market in the years to come. The huge decline in construction from 2006 through 2009 had the effect of dramatically reducing new home inventory. With new home formations continuing, however, the pent-up demand for housing is very likely to provide strong support for future gains in residential construction activity. The housing market is still in early innings.

Many would say that housing starts and the housing market in general were slowed down by the jump in mortgage rates that began six months ago. Similarly, it is tempting to say that activity continued to improve despite the rise in mortgage rates. But it is probably more accurate to say that mortgage rates have risen because housing market activity has improved.

Weak housing starts? Permits are a better indicator

April housing starts were sharply lower than expected (853K vs. 970K), but building permits were much stronger than expected (1017K vs. 941K). The past behavior of these two series suggests that in cases like this where starts are this low relative to permits, they usually come back into line with permits in the subsequent month. Thus it's reasonable to expect that starts will bounce back next month, and that the boom in residential construction activity is ongoing.

Not surprisingly, building permits and housing starts tend to track each other very closely, and it's reasonable to assume that builders must first acquire a permit before starting construction. Logic would thus suggest that the sharp divergence in these two indicators should be resolved in the direction of permits.

The above charts show the long-term history of the level of starts and permits and their ratio (on the bottom half of each chart). Note that the ratio averages just about 1 over time, which means that indeed the two series are measure two sides of the same thing: residential construction activity. The top chart gives a long-term view, while the bottom chart zooms in on the past several years. Note that April 2013 marked the lowest level of this ratio in the past 13 years. In fact, it was the lowest ratio in the entire history of these two series going back to 1960, and this strongly suggests that April starts were the outlier. Something similar occurred in December 2010, when permits rose strongly but starts were flat. The following month the ratio shot higher as starts surged.

Starts and permits have been rising at about a 30% annual pace for over a year, and there is no reason to think that this boom has suddenly come to an end.

Housing market update: slowing but not collapsing

I'm seeing a significant increase of late in stories which suggest that the housing market has peaked and could be in trouble. Not everything is rosy, to be sure, but from what I can see, the worst that can be said about the housing market is that it is cooling off. The following charts tell the story:

Chart #1

As Chart #1 shows, an index of the prices of homebuilders' stocks is down about 25% since last January. That's a big correction that could easily be the start of a major decline, much as we saw happen in 2006-2009. So: is housing history likely to repeat? It's tempting to say we've seen a major top in this market, but I would note that we have seen corrections such as the current one quite a few times in the past. If anything, it might just be the case that prices got a little too exuberant towards the end of last year and have now come back down to a more reasonable. level.

Chart #2

Chart #2 shows an index of housing affordability, which has dropped considerably in the past 5 years. But if you read the fine print at the bottom of the chart, you find that it is still the case that the average family has an income that is more than sufficient to qualify for mortgage big enough to buy a median-priced home using conventional financing. Prices are up and mortgage rates are up, but so are incomes, and the economy is in pretty good shape. All things considered, homes are still "affordable," only much less so than they were a few years ago.

Chart #3

Chart #3 shows that 30-yr fixed mortgage rates have been roughly flat at very low levels for the past six years. For most of my lifetime, today's 4 ½% mortgage rate would have been unthinkably low. Mortgage rates are not a problem in today's market.

Chart #4

Chart #4 compares the level of housing starts with an index of homebuilders' sentiment. Here we see that starts are still substantially lower than they have been in the past, while sentiment is about as healthy as it has ever been. This further suggests that there is plenty of upside to housing construction. On the other hand, starts have been relatively flat for the past year or so, so new construction appears to have run out of steam, at least for now. A pause that refreshes?

Chart #5

Chart #5 shows that building permits still appear to be in an upward trend. By past standards, we have yet to see a frenzy of home building. If anything, new housing construction has been relatively weak and continues to be so. 

Chart #6

Existing home sales also appear to have flat-lined in recent years, as we see in Chart #6.

Chart #7

Chart #7 shows the long-term history of housing starts. As with Chart #4 above, we see that starts are still quite low from an historical perspective.

Chart #8

Chart #8 shows that the inventory of unsold homes is still quite low. 

Chart #9

Chart #9 compares residential fixed investment (i.e., home building and related activity) to GDP. Here we see that residential construction spending is still very low compared to the rest of the economy. Activity has rarely been this low, in fact. Note the surge in activity that preceded the bursting of the housing bubble in 2005. We are nowhere near that today.

Chart #10

Chart #10 shows an index of the volume of new mortgage applications (i.e., mortgages originated for the purchase of a home, as distinct from mortgages originated to refinance an existing home). Here again we see that activity is still far below the bubble levels of 2005. Today, new mortgages are being originated at less than half the rate they were in 2005. Recall that a big factor behind the housing market collapse that started in 2005 was the wild and crazy way that banks were lending: inverse floaters, zero down payments, stated income, etc. Nothing like that is happening today. 

Chart #11

Chart #11 shows the real and nominal level of housing prices nationwide, according to the folks at Case Shiller. Here we see that prices have been rising in line with historical trends. Over the long haul, this chart suggests that housing prices in inflation adjusted terms tend to rise by a little less than 2% per year. This can be explained by the fact that houses today are bigger and better-appointed than they were in the past. Prices today are still well below their bubble highs when adjusted for trend growth and inflation.

One caveat to Chart #11: the Case Shiller methodology uses a three-month moving average of prices, reported with a 2-month delay. Thus, the prices reported today were the average of prices in the March-April-May period, and they were up some 5-6% from the previous year. It is likely that price increases have slowed considerably in recent months, if we are to believe the anecdotal evidence.

Taking all this into consideration, it looks to me like rising prices are the logical result of a scarcity of supply coupled with relatively strong demand. This can't go on forever, though. Prospective home buyers are being gradually squeezed by rising prices, a scarcity of supply, and a decline in affordability. Higher prices signal a relative scarcity of housing (with local zoning codes to blame in many areas, unfortunately), and higher prices are slowing housing activity in general by making it harder to afford a house. But there is no reason to think that prices are going to collapse, unless of course the whole economy collapses. The housing market is cooling off, but not about to collapse.

Housing continues to improve

December housing starts beat expectations (1089K vs. 1040K), but not by much, considering how volatile this series normally is, and how important seasonal adjustment factors can be. Missing from the headlines were upward revisions to the past two months. Pessimists will note that the level of starts in November 2013 was slightly higher than the latest reading, suggesting that starts have been relatively flat for the past year. I prefer to look at a 12-month moving average of starts: that shows starts last year were 8% higher than in 2013. That's pretty decent growth. Plus, as the chart above shows, the level of builder sentiment suggests conditions are likely to continue to improve, if only modestly.

From a long term perspective, housing starts today are still miserably low. That's depressing on its face, but the optimist in me sees the tremendous upside potential should underlying conditions continue to improve. Why couldn't housing starts double over the next 5 years or so?

Untapped potential is the story of the overall economy as well, as the chart above shows. The economy is currently about 10% or so below its long-term potential trend. If policymakers move in a growth-friendly direction (e.g., eschewing tax hikes, reducing regulatory burdens, simplifying the tax codes, lowering marginal rates, eliminating deductions and subsidies, lowering corporate tax rates) we could be on the cusp of some significant growth in the years to come.

It makes more sense to focus on what could happen if things go right, than to lament how many things have gone wrong.

UPDATE: The chart below shows an index of new mortgage originations (not refis). At the end of last year it had reached a multi-year low, reinforcing the widespread belief at the time that the housing market was running on fumes. But in the past three weeks, new mortgage initiations have jumped over 25%. (Caveat: this is a seasonally adjusted index, and this is the time of the year when activity is typically slow, so the adjustment factors are large and could easily be wrong.) We'll have to watch for further strength, but in the meantime this fits nicely with the noticeable pickup in bank lending in recent months that I noted yesterday.

What the Fed is overlooking

Yesterday the FOMC decided to keep its target Fed funds rate unchanged at 5.5%. That was no surprise to the market, but the tone of Powell's press conference and meeting minutes convinced the market that rates are likely to be "higher for longer" than previously expected. Market expectations are now geared to expect one more hike before year end, and only a few cuts by the end of next year. To judge by the market's reaction, there's a bit of panic in the air—maybe this time the much-feared recession that was just around the corner most of the year will finally arrive?

It's a shame that economic growth has come to be feared rather than welcomed. We've had 2% growth for over a year now, and inflation has plunged. Growth doesn't cause inflation; too much money relative to the demand for it is what does. The Fed was late to the tightening party, but they have delivered in spades. Today's high interest rates have boosted the demand for money by enough to result in a significant decline in inflation. 

It's terribly unfortunate, but the Fed worries that they haven't done enough, and that they may have underestimated the economy's strength. This tells me that the Fed is overlooking some very important developments: 1) the fact that inflation by current measures has already fallen within range of its long-term target (see Chart #7 in this post), 2) the ongoing slowdown in the growth of private sector jobs, and 3) the emerging weakness in the housing market. 

This post focuses on the housing market, which has suffered a triple whammy of soaring home prices, soaring mortgage rates, and soaring spreads over Treasuries that has combined to crush new mortgage applications, weaken housing starts and cool builder sentiment. 

Chart #1

Chart #1 shows the nominal and real (inflation-adjusted) index of national home prices according to Case-Shiller. (Note: the June figure is actually an average of April, May, and June prices). Home prices are within inches of their all-time highs, and 15% higher, in inflation-adjusted terms, than they were at the peak of the housing market boom in 2006. 

Chart #2

revise?????

Chart #2 shows the level of 30-yr fixed rate mortgages (blue), the level of 10-yr Treasury yields (red), plus the spread between the two (green). As is widely known, 10-yr Treasuries set the bar for fixed rate mortgages. In normal times, mortgage rates tend to be about 150-175 basis points higher than Treasury yields. Today, however, they are about twice as high as that (320 bps). Treasury yields have surged from 1.5% in early 2022 to now 4.4%, and mortgage rates have exploded from 3% to now 7.25%. Since the effective rate today on all outstanding mortgages is about 3.7%, anyone refinancing or taking out a new mortgage faces the prospect of a huge increase in mortgage payments on top of housing prices that have climbed to record levels. It's enough to make nearly everyone think twice. And what they're thinking is that borrowing money today is not a pleasant experience. That is how higher interest rates increase the demand for money: it's better these days to be long money than short money—in the sense that being "long" means you own it, while being "short" means you owe it. What a change from a few years ago, when I noted repeatedly that the Fed was encouraging people to "borrow and buy."

Chart #3

Chart #3 shows an index of new mortgage applications, which are down 70% from the highs of the mid-2000s, and down over 50% from the highs of late 2020. Housing market activity has been severely impacted by higher rates, and the Fed's stance today promises no relief for the foreseeable future. This is powerful evidence of an increase in money demand.

Chart #4

Chart #4 shows a measure of housing affordability, which today is as low as it has ever been, thanks to the combination of soaring home prices and soaring mortgage rates. (I would guess that the affordability of homes in the Los Angeles area would register about 60 on this chart.) 

Chart #5

As Chart #5 shows, since early last year existing home sales activity has dropped by 36%, to levels not seen since the depths of the housing market slump in 2010. Very few want to sell, and very few are able to buy. This is evidence that the housing market is unstable. Very low turnover means that prices are not a reliable indicator of value.

Chart #6

Chart #6 compares housing starts to an index of homebuilder sentiment. Both have dropped sharply from the highs of the past few years. Since early last year, housing starts have fallen almost 30%, and homebuilder sentiment has dropped by almost 50%. Over the same period residential construction spending has dropped about 10%—with further drops very likely to come in the months ahead (residential construction spending is highly correlated to housing starts, but with a lag). 

All of this is reason enough to question the overall strength of the economy. Lurking in the background are $2 trillion annual deficits fueled by excessive and wasteful government spending, the Biden administration's recent throttling of oil exploration and drilling activity, and soaring energy prices. Very expensive energy, just like high taxes, are sure-fire ways of throttling economic growth. Too much government spending is almost guaranteed to sap the economy's strength.

Conclusion: The Fed is highly unlikely to deliver on its "higher for longer" interest rate target for much longer. In coming months events are likely to transpire which will convince both the Fed and the market that inflation is lower and the economy is weaker than commonly thought. And that interest rates need to come down.