2008 and 2018 had one thing in common – neither was particularly good for housing-related stocks. Home builders, furniture makers, and suppliers of home supplies all struggled. But the housing market is far healthier today than it was in 2008. In 2018, home affordability declined, mortgage rates increased, and fears a U.S. economic slowdown accelerated. Despite these headwinds, housing stocks are much better positioned for a rebound in 2019. Housing in the U.S. makes up about 15% to 18% of GDP and there are indications that the housing market is looking healthier in 2019 due to slowing home price appreciation, lower mortgage rates, and household balance sheets which continue to improve.
The fairly rapid home price appreciation of the last few years appears to have slowed from its recent peak of 6.5% year over year in March 2018 to 5.2% as of its most recent reading as measured by the S&P Corelogic Case-Shiller US National Home Price NSA Index.
While a 5.2% increase is still a healthy rate of advance, it is a deceleration nonetheless and this slowing, when taken with the level of mortgage rates, provides some optimism that the recent housing slowdown may abate in 2019.
Mortgage rates rose by nearly 1% from November 2017 to November 2018. This likely contributed to a case of sticker shock for home buyers and, in particular, first-time home buyers who don’t recall mortgage rates over 5% (not everyone remembers the very high mortgage rates of the early 1980s). This led to a slowdown in new and existing home sales throughout 2018. Whether this slow down would have been temporary or permanent would have been hard to assess at the time. Several years ago, when gas prices soared to over $4 per gallon, drivers initially pulled back consumption, but driving resumed as consumers became more accustomed to the higher price. Nonetheless, since reaching a high of 4.8% in early November 2018, the 30-Year mortgage rate has rolled over to a more palatable 4.4% which will help support a rebound in housing-related activity.
Our recent commentary, Where Did the Bear Market Go, aptly pointed out that the fear of a recession could actually prolong the current expansion due to more cautious spending from consumers and firms. Indeed, projections for first-quarter GDP growth have declined modestly and we are seeing the 10-Year U.S. Treasury reflect this as well with the current yield down to 2.7% from over 3.2% in November 2018. This decline is all the more impressive because of the very strong employment numbers, the Fed’s quantitative tightening, and China’s reduction in treasury holdings to their lowest levels since May 2017. Not only are lower mortgage rates a tailwind for housing, but the Fed also provided additional support last week when it communicated a more dovish positioning toward the economy and interest rates.
Much has been made of banks deleveraging. But improving consumer balance sheets are another significant contributor towards an improved housing climate. Household debt as a percentage of disposable income continues to improve as it reached its lowest levels since the early 2000s, a fact that has gone largely overlooked. This deleveraging is significant and should provide a tailwind for the both the economy and housing builders.
PulteGroup is the third largest homebuilder in the U.S. Its CEO had this to say regarding the current housing market, which we think captures our points:
“Many point to the rise in interest rates that accelerated in Q2 of 2018 as the trigger for the change in consumer behavior. I think the rise in interest rates may be better viewed as the proverbial final straw rather than a trigger as it came on top of several years of home price appreciation and growing affordability challenges. The combination of these things, coupled with global trade and geopolitical unrest, was enough to move potential buyers to the sidelines and create a general sense of uncertainty. Consistent with much of the commentary issued over the past several weeks, we too experienced a sequential improvement in qualified buyer traffic to our communities as interest rates moved lower. On a per store basis, traffic was lower in October and November compared with last year, but the trend turned positive in December. It is worth highlighting that we remain constructive on the market. As a result, we believe there is potential for improving or at least more stable demand due to the fact that the broader operating environment remains strong in terms of a growing economy, great jobs numbers, rising wages and continued high levels of consumer confidence.”
The market for entry-level housing has remained a bright spot in the housing sector, and as mortgage rates have stabilized incomes have continued to rise, and household balance sheets have improved, we expect housing strength to become more widespread in 2019 and to provide a solid tailwind to housing-related stocks.
Sources: Bloomberg terminal and PulteGroup’s Q4 2018 Earnings Call Transcript