The Boom is Burning Brighter, but Beware Markets Getting Spooked
Home prices reached new all-time highs in August and the economy is roaring. But the early innings of the Great Recovery are over and late-cycle concerns are rising.
This morning the U.S. National Home Price NSA Index rose 6.8% in August, according to data from S&P CoreLogic Case-Shiller. This latest report comes on top of a reported increase of 5.9% in July. "Home prices have reached new all-time highs," S&P Dow Jones indexes managing director David Blitzer told CNBC.
"Home price increases appear to be unstoppable," Blitzer added.
Record home prices also comes with news today that U.S. consumer confidence just hit its highest level in ~17 years. And this morning the MNI Chicago Business Barometer surprised with a much better than expected reading 66.2 as well, which was the highest level since 2011. Even more impressive, new orders rose at the fastest pace since February of 1974.
And Chicago is not alone. Across America factories ramped up in October, by looking at the latest regional manufacturing indexes. As Bloomberg reported: “[f]rom Milwaukee to Dallas to New York state, measures improved to multi-year highs, reflecting robust orders growth as the global economy shows some promise.” In Texas manufacturing business activity was the firmest in more than 11 years, according to a report by the Federal Reserve Bank of Dallas yesterday. The Kansas City Fed’s measure of regional activity advanced to the strongest reading since March 2011; and its index of backlogs climbed to a 13-year high. Meanwhile, the New York Fed’s Empire State factory index climbed to its highest reading since September 2014.
Around the world, all major developed economies are growing in sync, a very rare moment of ubiquitous expansion in all 45 countries tracked by the OECD.
Housing and labor markets are on fire.
Job openings hover at all time highs and the only thing tighter than the labor market is housing. According to a report released by the National Association of Realtors (NAR), U.S. homes currently sit on the market for a record low average of only 3 weeks. It was the shortest time since NAR began reporting its data for how long homes spend on the market in 1987, as reported by Bloomberg. The inventory trend is more strong evidence of a growing shortage of housing. As shown by NAR’s data, the number of available properties fell again in September in the 28th consecutive month of year-on-year decline in the housing stock.
With ever-growing demand and limited supply, buyers are in greater and greater competition. Bidding wars are more frequent. Though they are also ending so quickly because, as Bloomberg notes, “[i]n addition to moving fast, buyers also had to pony up to close the deal. Forty-two percent of buyers paid at least the listing price, the highest share since the NAR survey started keeping track in 2007.”
If that's not a seller's market, then we don't know what is. But the seller's gain can be the buyer's pain, and a bar to would-be buyers who are getting priced out.
“With the lower end of the market seeing the worst of the supply crunch, house hunters faced mounting odds in finding their first home,” Lawrence Yun, chief economist at NAR said in a statement. “Multiple offers were a common occurrence, investors paying in cash had the upper hand, and prices kept climbing, which yanked homeownership out of reach for countless would-be buyers.”
Adjusting our view.
In last month’s BL premium newsletter, we moderated our macro view of U.S. markets. We see a growing number of signs indicating mature, stretched and overshot segments and markets—though these appear to be primarily local and regional stories that do not yet compel broader concerns. Global changes continue to translate in vastly different ways at the local level, but signs of trend-shift are everywhere. London home prices fall for 1st time in 8 years.
Robert Shiller, co-inventor of the Case-Shiller Home Price Index now hitting all time highs, has joined the camp of the cautioned and concerned. “The US stock market today looks a lot like it did at the peak before all 13 previous price collapses. That doesn't mean that a bear market is imminent, but it does amount to a stark warning against complacency,” he wrote last month. We don’t analyze stocks, but we do see parallels to this in the real estate market… which Shiller is also concerned about.
We aren’t alone in perceiving a growing propensity for a correction. Already vultures are beginning to circle commercial real estate and investors are raising funds to target distressed properties. Should the economy come under stress, they may get their chance to pick the bones of opportunity from weak hands.
BL outlook: shallow bottom.
Interest rates finally seem sure to rise. Risks that the economy may overheat are beginning to materialize, but no specific fundamental catalyst for a major correction is looming on the horizon. Sources of significant stress could emerge elsewhere. Political risk in the U.S. continues to rise. And geopolitical hotspots around the world seem to be graduating beyond the usual fire drills. Any of which could give the markets ample excuse to take a break.
As a result, we are shifting the general BL outlook to a more cautious view.
A downtown at this stage could be a healthy, market cleansing event. It may take some time yet to materialize. Fundamentals and macro trends are still very strong and BL’s long term view is still very constructive. There’s still way too much dry powder and cash lying around (a record) fortifying balance sheets for contagion scenarios to be of great concern.
While the most identifiable risk may be overheating, with some areas overshooting, two of these markets, Houston and South Florida, were just hit with historic hurricanes that will help cool them off. And if the economy is overheating, then it could still take quite some time for the proverbial steam to bust the economy's seams. Over that horizon, rising interest rates could become a source of concern should the Fed get behind a runaway boom and have to play catch-up with interest rates—but that can take an entire cycle to play out.
In the short term, recent weather events have shown just how unready our built-environment really is for the here and now (nevermind the future). The immediate effects of which are making some of our very problems worse, particularly high labor and materials costs.
And yet, U.S. homebuilders are feeling more optimistic than they have in months. The National Association of Home Builders/Wells Fargo builder sentiment index released this month rose to its highest reading since May. And a bounce from a drop in September when homebuilders were feeling less optimistic about sales prospects, on concerns that rebuilding efforts following hurricanes Harvey and Irma would drive up costs for construction labor and materials.
Should a correction come, we expect it will be shallow. In this time of great reconfiguration, any pull back will be met by strategic buyers waiting with huge, historic cash hordes for opportunities to expand into the new long games emerging in businesses of all kinds across the spectrum—especially the industrial segment, which continues to run to new new highs. The new and powerful structural trends that became dominant in post-2008 pivot will not be undone by any regular, cyclical recession.
This bull market may not be blunted by simple fatigue, but it may be graduating into more mature complications. We’re in the midst of an affordability crisis. Even though median income in 2016 rose for the second straight year to a new all time high, as reported by the Census Bureau last month, home prices are rising even faster. So while average hourly wages may be growing at a respectable 2.9%, home prices in 15 of 20 major U.S. cities are growing at 5% or higher per the latest Case-Shiller report (above). As Bloomberg also noted recently, rising rents are pushing more tenants past the breaking point. Almost 20% percent of those surveyed recently reported that they struggle to pay the rent.
Tide of urban resurgence cresting?
This rotation was one of the eight things to watch in BL’s last yearly outlook, where we said:
The next thing to watch in the last BL yearly outlook was a “suburban resurgence,” where we noted:
So, it’s not that the urban revival is “over,” as Florida fears, so much as other environs are catching up in the amenities arm’s race while simultaneously increasing their cost competitiveness. With urban cores too hot for an increasing number of buyers to enter, the suburbs are the only choice for a growing segment of the market—whatever their urban aspirations might be. As we wrote in last year’s forecast, “[a]s capital spills over into these secondary markets and the quality of design, amenity and place catches up to urban markets, demand distribution should begin to equalize.”
New urban crisis?
In his new book, "The New Urban Crisis: How Our Cities Are Increasing Inequality, Deepening Segregation, and Failing the Middle Class—and What We Can Do About It," Florida takes new looks at several theories behind the trends toward urban inequality and unaffordability, such as gentrification.
The real culprit behind the deepening urban crisis, Florida asserts, is simply a lack of investment in infrastructure that benefits everyone equally. Poor neighborhoods and residents are getting largely left out of what little infrastructure investments are being made. This is why, even as so many macroeconomic metrics are making new all time highs—and the middle class is making a quiet comeback—a growing chorus of observers note that large parts of America are being left behind by today's economy.
Recent economic prosperity is concentrated in America's elite zip codes, while many remain stagnant. Some are worse, and continue deteriorating into states of physical and psychological depression. Despair has helped fuel an explosion of chemical dependency. So much so that middle-aged Americans are dying at alarming rates—enough to lower average life expectancy for the first time in modern history. Opioid use may actually help explain as much as 20% of the drop in the male labor force participation rate.
Florida’s recipe is to, among other things, build more affordable housing and more cheap public transit in a sweeping “urbanism for all” policy. It would require the kind of infrastructure surge we need, but a correction is likely to come before the national infrastructure surge policy both presidential candidates seemed to agree was necessary last year.
In the meantime, color us more cautious and pick your projects a bit more carefully. And brace for yet another record-breaking, door-busting holiday shopping season to close 2017. Come what may, the “placemaking hot war” we foresaw in the last BL yearly outlook went thermonuclear with the announcement of Amazon’s second headquarters, HQ2, and will continue to escalate. As we wrote then: “Looking ahead, the quality of place cold war has turned into a placemaking hot war, because everyone has finally realized that people like to walk in parks and sit for a coffee, beer or book in a pleasant public place. Amenities sell real estate and make people happy. Look for cities to seize on opportunities for multi-functional amenities, like green infrastructure, which can add green space and public space while also helping to manage storm, flood and waste waters more sustainably and cost-effectively.”