The
housing market recession is coming.
In
recent months, we’ve seen shares of homebuilder stocks get hammered. Existing and new home sales have declined sharply. And the pace of home price appreciation has now declined for six
straight months.
The
factors weighing on housing are not particularly new or novel — a lack of affordable housing supply and the rise in mortgage rates to seven-year highs are pressuring the
market.
The
latest data on homebuilder sentiment shows a sharp downturn in confidence
during November with the NAHB’s housing market index falling by the most in 8.5 years. And
recent earnings from one of the country’s most prominent homebuilders isn’t
going to bolster sentiment in the space.
On
Tuesday, Toll Brothers (TOL) called out weakness in California, the company’s highest
revenue state. “California has seen the biggest decline,” Douglas Yearley,
Jr., chairman and chief executive officer at Toll Brothers, said in the
company’s quarterly earnings release. “Significant price appreciation over
the past few years, fewer foreign buyers in certain communities, and the impact
of rising interest rates all contributed to this slowdown.”
In
2017, California accounted for over $1.5 billion in revenue
for Toll Brothers, the largest for any one of the company’s regions. (Toll
counts California as a standalone region.)
Yearly
added, “In our fourth quarter, despite a healthy economy, we saw a moderation
in demand. Fourth quarter contracts declined 15% in dollars and 13% in units
compared to a difficult comp from one year ago. Fourth quarter demand slowed to
a per community pace more consistent with FY 2016’s fourth quarter, which was
still strong.
“In
November, we saw the market soften further, which we attribute to the
cumulative impact of rising interest rates and the effect on buyer sentiment of
well-publicized reports of a housing slowdown. We saw similar consumer behavior
beginning in late 2013, when a rapid rise in interest rates temporarily
tempered buyer demand before the market regained momentum.” Bloomberg notes this was the first decline
in orders for the company since 2014.
On
a day that stocks got hammered, however, Toll Brothers held up relatively well,
falling 1.6% while the S&P 500 dropped more than 3%. So far this year, however,
shares of Toll Brothers are down over 30%.
With
a slowdown clearly coming to the housing sector, the question then becomes how
much an ailing housing market will hamper the overall economy. The crash in oil
prices and the resulting impact on markets and the economy seen back in 2014-15
could provide a potential roadmap, and an encouraging one for those who see the
current expansion sustaining itself.
Cullen
Roche, founder of Orcam Financial Group, floated the idea Monday that in 2015 we
experienced an “undercover manufacturing recession” in the U.S., but that the
overall economy kept growing due to increasing diversity within the economy. In
2020, Roche posits, we could see a similar dynamic play out with housing
serving as the point of stress.
After
oil prices crashed and oil-producing wells were shuttered across the country,
we saw oil and gas production fall more than 60% while business investment dropped more than 30%. Investors also
dealt with an earnings recession that resulted from
declines in the energy sector and foreign economies that were pressured by a
rapidly-strengthening U.S. dollar.
Oil
prices eventually recovered, President Trump was elected president and vowed to
cut corporate taxes, and thus was born a new leg of the economic expansion and
the current bull run for stocks.
Of
course, the housing market — which comprises a little less than 14% of GDP — is a
larger part of the overall economy than the oil and gas industry (the mining sector constituted just under 2% of GDP in the second
quarter of this year). Comparing housing and the oil industry is clearly not an
apples to apples comparison, but this can serve as a potential guidepost for
how the economy has reacted to recent stresses in one sector.
The
drop in oil prices, we should also not forget, was a boon to consumer spending
— with some economists estimating this amounted to a
$60 billion tax break — which accounts for around 70% of GDP. As
long as consumers remain in good shape, the economy is likely to hold up.
And
though many consumers get a large part of their net worth and purchasing power
from the value of their home, the current downturn in housing does not point to
an outright decline in home values, but rather a moderation in the appreciation
of home values. As Yearly said Tuesday, “equity in existing homes is at an
all-time high, providing significant liquidity for current home owners who want
to upgrade to a new home.”
Workers,
particularly those in the lowest tiers of the income distribution, also continue to see
their wages rise at the fastest pace since the financial crisis. Neither factor
sounds like one that would prompt consumers to drastically rein in their
spending.
Though
as we noted Monday, financial markets are currently pricing in
a downbeat overall economic forecast. After a brief reprieve for markets around
optimism for easier Fed policy and a resolution of trade tensions, Tuesday’s
action suggests this trend is still in place.
Current
dynamics in the bond market are raising concerns among some investors, with the
recent inversion at the front-end of the yield curve — with the yield on two-
and three-year Treasuries exceeding the yield on 5-year notes — raising worries about recession.
And
the softness that we’re seeing in the housing market isn’t likely to put at
rest many of the economic concerns we’re seeing expressed in markets. But if
recent history is anything to go by, there is a path for a slowdown in a big
part of the economy to potentially come and go without an outright contraction
in economic growth following. Though the market, it seems, remains somewhat
wary of betting on that outcome
Click here for the original
article.