We’re at a point in the economic cycle where depending on your opinion of whether we’re headed for a serious downturn or not, you can find the data to support your argument. For every data point that warns us something ominous looms in the not-so-distant future, there is someone with an equally compelling counterpoint.
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How can we make investment decisions amid such conflicting information? We have to stop looking at the opportunity set as emphatically one of two possibilities — good or bad — and instead start examining with a narrower lens on certain industries.
Last week, I wrote about what I called the possibility for a soft or “suave” landing and the market’s rather newfound belief that it’s possible. I happen to believe the same, but maintain the stance that even if we are headed for a serious contraction, it’s more likely a 2023 story.
That said, there is one sector of the economy sending decidedly “hard landing” signals, and that is housing. Even if you have a degree of confidence that things aren’t that bad, or won’t become that bad, it’s important to seek out competing data and keep it in the bin of possible “thesis busters.”
On Tuesday, the latest data on housing starts came out, and it was almost shockingly bad. July posted a 9.6% decline month-over-month vs. the expected decline of 2.1%. Add that to a sharp drop in pending home sales, declining building permits, a drop in homebuilder sentiment, and 16.1% of home purchase agreements being canceled in July (the highest level since Spring 2020) — and it’s clear that housing has hit a rough patch.
Housing is an important indicator of economic activity for several reasons. For starters, it bears a direct relationship to the consumer’s ability and willingness to borrow and spend. A slowdown in housing at this point doesn’t necessarily mean a big wave of mortgage delinquencies or foreclosures are coming, but it does indicate consumers are likely exiting the market.
That could be due to decreased affordability (increasing mortgage rates amid rising home prices), or because consumers are worried about their economic prospects in the near-to-medium term…or both. Either way, it’s not exactly a signal of increasing growth and prosperity.
Housing is also a cyclical barometer of economic activity. A slowdown in this sector typically results in a ripple effect across other sectors such as construction, building materials, and retailers closely tied to home improvement, furniture, or home electronics. Not to mention, if fewer homes are being built, fewer workers are needed to build them, which has an effect on unemployment.
Those of us who lived and worked through the 2007/2008 housing market collapse have a special sensitivity to this topic. If you’re like me, seeing bad data on housing makes your blood pressure rise immediately. The good news is, we’re not in the same situation from a leverage standpoint, nor a banking sector standpoint, that we were in 2008. The bad news is, the data is likely to get worse before it gets better.
The whole point of monetary tightening is to soften demand and reduce inflation. We can all agree on the objective, but what we may not agree on, nor view the same way, is whether we’ll be able to close the door on housing without slamming it. Even in the ideal scenario where inflation falls rapidly to a more manageable level, home prices are likely to fall with it. This means anyone who bought while home prices were on the rise, could see the value of their real estate fall below the purchase price, a scenario that doesn’t exactly give consumers the warm and fuzzies.
As economic data softens further, markets may actually strengthen. That scenario would be a flip from the first half of the year where markets were sending a sour message while economic data kept saying, “why so scared?” As it goes, the two are rarely in lockstep. If the market is right and we manage to maneuver a suave landing, the best of the returns are likely to be seen through the rest of this year, with more muted movements in 2023 (which I’ll cover in a later note). Enjoy the ride, with your eyes wide open.
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