Equities | Monetary Policy & Inflation | US
At the recent post-meeting Fed press conference, Chair Jerome Powell noted the strong housing market and rising house prices and suggested the trend would soon pass. He attributed it largely to people making adjustments to their housing situation due to the coronavirus crisis.
First, on housing, both existing and new home sales have surged powerfully in the second half of 2020 (Charts 1 and 2). Housing starts have surged to 1.4 million units on an annualized basis after spending nearly 15 years mired well below 1 million. Home prices jumped 9%, according to the respected Case Shiller National Housing Price Index. The National Association of Realtors’ median price index is up 15%. Both indices recorded annual gains of around 4-5% for the previous seven years.
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
Summary
- Fed Chair Powell recently suggested that the surging housing market of 2H 2020 is due to people adjusting to the Covid-19 economy and is unlikely to persist.
- Housing is in transition. But by the time the pandemic subsides, we think housing supply and demand will be roughly balanced for the first time in 15 years. That’s good – but not great – for housing.
- We would pay heed to Powell’s words. For housing to keep booming, the housing finance system must seriously open the spigots. We doubt Powell will let that happen.
Market Implications
- Housing-related ETFs such as XHB and ITB have handily outperformed the S&P 500 by 40% since the March 2020 lows. If Powell is right – and underlying fundamentals strongly support him – the housing ETF boom will soon end.
- At this point in the cycle, we favour PKP, a construction and engineering ETF with broader exposure to companies that will benefit from any infrastructure program that the Biden administration pursues.
Housing Has Been on a Roll…
At the recent post-meeting Fed press conference, Chair Jerome Powell noted the strong housing market and rising house prices and suggested the trend would soon pass. He attributed it largely to people making adjustments to their housing situation due to the coronavirus crisis.
First, on housing, both existing and new home sales have surged powerfully in the second half of 2020 (Charts 1 and 2). Housing starts have surged to 1.4 million units on an annualized basis after spending nearly 15 years mired well below 1 million. Home prices jumped 9%, according to the respected Case Shiller National Housing Price Index. The National Association of Realtors’ median price index is up 15%. Both indices recorded annual gains of around 4-5% for the previous seven years.
Housing supply is at or near record lows. The NAR reports that there is only two months’ supply of existing homes on the market at current selling rates. The previous low over the past 20 years was four months’ supply. New home supply is running around four months – in line with previous lows in the years around 2000. Last but not least, the NAR’s index of housing affordability is high at 168, meaning the median family has 168% of the income needed to buy the median-priced house.
The pump would appear primed for housing to keep booming – at least as long as mortgage rates remain near 3%.
…But Good Reasons Exist to Think It Soon Slows
There are some caveats. Much of the huge surge in housing was surely payback for plunging activity during 2H2020. The 12-month moving average of new and existing home sales is probably the better indicator for 2021. This implies a good outlook, but certainly nothing like 2004-2006!
A second factor that supports housing – but not a boom – is underlying demographics. Over time the supply of housing grows in line with growth in households. Between mid 1980s and early 2000s, there were about 1.12-1.13 housing units per household (Chart 3), implying balanced housing supply and demand. The excess units were mostly vacation/second homes and unoccupied rental housing.
During the housing boom of 2003-2007, that jumped to 1.18 units per household. Since then, society has been working off that excess inventory. (This is also visible in the drop in occupied housing units, from 89% to 85%).
In 2020, units per household suddenly turned volatile, plunging to 1.10 then jumping to 1.12. The underlying reason was a sharp jump in the number of households in the second quarter followed by a decline in the third quarter. Barring some statistical anomaly, it most likely reflects some households disbanding when the coronavirus hit, with some people moving to second homes or rental properties, and then this effect unwinding when the economy reopened during the summer. This movement of people and households has stimulated new housing demand.
When the dust settles and Covid-19 is behind us, we will likely return to a housing market with supply and demand roughly balanced again for the first time in 15+ years. Homebuilders might be eager to build (‘if you build they will come, no?’), but if Powell has any say in the matter the legacy banking and mortgage finance industries will not be providing the punch.
It’s probably worth heeding his views on the housing market.
Time to Switch From Housing to Infrastructure Plays
Housing markets may finally be overcoming the financial-crisis hangover, but housing equities are still dragging. Measured from the housing peak in 2006, two ETFs that represent the homebuilding industry – XHB and ITB – underperformed the S&P 500 by 40-50% (Chart 4a). In early 2020, they managed finally to recover to 2006 levels.
That underperforming streak continued during the period starting in 2018 through early 2020, with housing ETs underperforming the S&P 500 by 20% (Chart 4b). But after the market low, XHB and ITB took off; outperforming by 40%.
For housing equities to keep rallying and close that 2006-2021 gap, housing must maintain its 2H 2020 pace.
There may be some momentum benefit left in the housing sector, but we side with Powell on this one. That isn’t going to happen.
Going forward, we see more upside in the infrastructure trade than the housing trade. PKB is an ETF that focuses on the broader engineering and construction sector rather than just housing. Over the 2006-2021 period, PKB basically moved in line with the S&P 500. However, it has lagged since 2018 and underperformed housing more recently as it became increasingly clear that the Trump administration and Republican Congress had no intention of delivering on an infrastructure rebuilding agenda.
Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)