Tuesday, November 1, 2016

ISM positive, construction spending confirms flattish housing market

 - by New Deal democrat

This morning we got our first October economic report.  The ISM manufacturing index was again weakly positive at 51.9.  The more forward looking new orders sub-index was a little bit more positive at 52.1.  The new orders component in particular was about at its average for this entire year, telegraphing continued weak expansion.

So let me turn some extra attention to the report for construction spending for September.   This was negative for the second month in a row, and has been essentially flat for over a year:

Although I won't put up a graph, YoY total construction spending is slightly negative at -0.2%.

When we break down construction spending into its components, it is easy to see that residential spending turns first (red in the graph below), followed by nonresidential (blue), and finally with a big lag, public construction (green right scale):

Let's take a closer look at the last couple of years.  Both residential and nonresidential peaked early this year, and have declined slightly since then:

Finally, let's see how residential construction spending compares with an important leading indicator, housing starts (as usual for the last year, I am choosing this metric vs. permits because permits were greatly distorted by an NYC tax break in spring 2015):

Construction spending follows housing starts with a slight lag (although they have the virtue of being much less noisy).  Starts have been going sideways for about 18 months, and construction spending followed the trend a few months later.

So I look at construction spending as simply confirming what we have seen with the longer  leading indicators in the housing sector.  I continue to expect a little bounce in starts as summer's low mortgage rates filter through the system.  But for the foreseeable future, I expect the slightly lagging construction spending series to remain essentially flat.
My outlook differs from that of Bill McBride a/k/a Calculated Risk a/k/a the Nicest Guy in the Econoblogosphere, who expects housing to pick up in the next few years (and has been cited for that proposition by Econbrowser's Prof. James Hamilton.  While I have great respect for both, my question is, if you are correct, then why has housing been so flat for the last year or more?  Wan't your dynamic already in place?  Why hasn't it played out in the last 12 months?

My view is that housing is driven first and foremost by interest rates, with an assist from demographics.  Demographics are positive, which is why the increase in interest rates in late 2013 only made the housing sector go flat, not down.  But without meaningful new lows in interest rates, history going back 60+ years says that the housing sector will remain stalled at best.