An exception to the rule? Maybe Housing ISN’T the Business Cycle

 

 - by New Deal democrat

Twenty years ago, Professor Edward Leamer gave an important presentation at the Fed’s Jackson Hole meeting entitled “Housing IS the Business Cycle.” The current environment is putting that hypothesis to a very severe test. Because by all accounts housing has deteriorated  sufficiently that a recession should already have begun months ago. In fact, the current situation would be most congruent with such a recession ending! And yet, here we are. 

Let’s take a more detailed look.

As I often do, let me start with mortgage rates (blue, left scale) compared with single family permits (red, right scale). Typically housing permits and starts follow mortgage rates, and for most of the past several years they had been declining from their post pandemic high of over 7%. In February they made a new 3+ year low of 5.99% before the Iran war oil shock drove rates higher, to 6.67% earlier this week. The decline in rates before March had been sufficient to reverse the trend in single family permits (red, right scale), which began to rise from their bottom early last summer:

In April, housing starts (blue), which are noisier and slightly lag permits (gold), declined -42,000 to 1.465 annualized. Permits rose 79,000 to 1.442 million. But the metric which is the least noisy as well as being most leading, single family permits (red, right scale), declined -23,000 to 872,000 annualized: 

On the one hand, the recent increase in mortgage rates may well be behind the decline in single family permits to their second worst level in three years. But what appears most noteworthy about the above data is that the downward momentum in the numbers has almost completely stalled since last June. Single family permits have varied between 867,000 and 929,000, while total permits have varied between 1.347 million and 1.540 million. 

On a YOY% basis, starts are down -4.6%, while permits are down only -0.2% and single family permits are down -8.5%:

As I noted last month, the YoY downtrend has not been worsening for many months. Typically all three have been down 20% or more at the onset of recessions in the past, although in the 1991 and 2001 recessions, they were only down about -10%; and there have been a number of times, for example 1966, 1987, and 1995, where construction has been down -10% or more YoY without a recession occurring:

Further, negative but relatively minor and stable negative YoY changes have been just as consistent with mid-expansion slowdowns as with recessions, and stable if negative YoY changes have sometimes occurred during recessions a few months before recoveries.

Let’s turn next to the number of housing units under construction. As I have written many times in the past several years, it is the best “real” measure of the economic impact of housing. In March they were rose slightly to 1.275 million annualized, just above their five year lows, and down -25.6% from their peak:

The above graph shows how they have followed single family permits (red), as expected. More often than not in the past by the time a decline in units under construction had declined by this much, a recession had already begun. 

Now let’s update the graph of the typical final shoes to drop before recessions, including houses for sale (gold) and residential construction employment (red, right scale), both normed to 100 as of their respective post-pandemic peaks. Since December, both of these have stabilized at down roughly -5% and -2% respectively, from their peaks:

As I concluded last month, this is a quandary. For nearly the past year, almost all of the indicators in the housing sector have been giving classic signs that a recession should already have been underway. And while a number of coincident indicators, including jobs and real personal income, have been consistent with a shallow recession since then, others - most notably real manufacturing sales and industrial production - have continued to increase.

But instead, as discussed above there are a number of signs that the situation has been bottoming, without a recession having occurred. While the renewed upturn in mortgage rates may, and likely will, cause at least some further downturn in housing permits and starts, at the moment Leamer’s thesis is facing a severe test, to say the least.

Jobless claims continue to be the most positive leading indicator of all

 

 - by New Deal democrat

I’ll get to housing permits and starts later this morning. But first, let me take my regular look at initial and continuing jobless claims. As a reminder, I look at jobless claims because historically they have been a very good short leading indicator for the economy.

And they continue to forecast no imminent recession ahead. For the week, initial claims declined -3,000 to 210,000, still historically in the lowest range going back over 50 years. The four week moving average declined -1,500 to 202,500. Aside from one week each in 2019 and 2014, plus one month in 2022, this is the lowest number since the late 1960s, when the US population was only about half of what it is now. Finally, continuing claims rose 6,000 to 1.782 million, in the lowest range it has been in since 2024:

On the YoY basis more important for forecasting purposes, initial claims were lower by -7.1%, the four week moving average by -11.8%, and continuing claims by -5.7%:

Needless to say, this is a very positive short term indicator for the economy.

And that positive indication extends to the unemployment rate as well, since jobless claims lead that metric by several months:

Initial and continuing claims forecast that the unemployment rate will decline in the next several months to the 4.0% range.

The asterisk with regard to jobless claims is that it likely has been affected by the situation with immigrants, although the exact manner is murky. Most likely even legal hispanic immigrants are reluctant to file claims, where it might attract attention from ICE for a “Kavanaugh stop” or worse. But the fact remains, it is the most positive indicator of all for the economy at present.

The current inflationary impulse does not appear to be ebbing in May

 

 - by New Deal democrat

The drought of significant official economic data continues today, but this is a good time to update my forecast for the effect of the spike in gas prices on inflation, specifically for May.

To reiterate, my back of the envelope calculation is to take the percent change in the price of gas, divide it by 16, and then add 0.15% for the average gain in other prices over the longer term. It’s definitely not exact, but it does serve as a good first order estimate. 

So let’s put together the pieces.

The most updated data we have is from GasBuddy, which estimates that for the last two weeks, national gas prices have averaged $4.50, +/-5 cents:

Yesterday the Department of Energy updated their weekly average, which came in at $4.49. On a monthly basis, so far May has averaged $4.48, a $0.38 increase over April’s $4.10 average:

That’s a 9.3% increase in gas prices for the month so far. When we perform my back of the envelope calculation, that amounts to a 0.7% increase in CPI in the month of May (blue in the graph below). But because shelter also plays such a huge role in consumer inflation (about 1/3rd of the total), the below graph in addition to showing headline CPI (red) also includes CPI less shelter (gold):

My forecasting method matches CPI ex shelter somewhat more closely than headline inflation.

So let’s take a look at shelter inflation. My forecasting method for that uses a 12-18 month lag in Owner’s Equivalent Rent, which has continued to decelerate slowly:

In the graph above, you can see that, with the outstanding exception of last month, shelter inflation has been trending in the +0.2% monthly range. If that continues, based on the current increase in gas prices this month, I would expect headline inflation to come in at 0.5% - which, as it happens, is the (rounded) current estimate for May inflation by the Cleveland Fed:

So, what would a 0.5% increase in CPI in May portend for real wages and payrolls? Here’s the month over month change in each for the past 12 months:

Nominal monthly wage gains have averaged 0.3% in the past year, while nominal payroll increases have averaged between 0.4% and 0.5% in the past six months. Which means that if the CPI increases 0.5% in May, real nonsupervisory wages will decline further both monthly and YoY, and real nonsupervisory payrolls will at best stay even monthly, but remain below their peak from last December. Which in turn means that there is an increased likelihood that consumers will start to cut back on other purchases, although we won’t find that out until personal income and spending are reported at the end of this month.

Finally, there is reason to suspect that gas prices at the pump will increase somewhat further by the end of the month, because gas price futures have been hovering near the top of their range for the past week:

We’ll see, but the bottom line is that the current inflationary episode does not appear to be ebbing yet.

The bond market is sending a message

 

 - by New Deal democrat

The bond market is sending the T—-p Administration, and the US government as a whole, a message. It believes the US is in a secular inflationary trend. 

This is not only because T—-p’s tariffs, and his boneheaded war with Iran, are inflationary, but also because last year’s Big Budget Bust-out Bill which doles out $trillions to billionaires, the attempt this year to vote more $Billions to ICE, and even T—-p’s personal raid on the Treasury yesterday, all are gradually moving the US closer towards an unsustainable fiscal situation. 

To wit, yesterday yields on the 30 year US Treasury bond (dark blue) made a new nearly-20 year high, at 5.14%. The 10 year Treasury (light blue) also broke out to the upside, with a yield of 4.59%, which is not quite at the peak of its post-pandemic range, but close. Even the 2 year Treasury (orange) made a new one year high. The below graph also shows the 3 month Treasury (gold) and the Fed funds rate (red), all over the past four years beginning with when the Fed started to raise rates:

What is noteworthy over this time scale is that, with the exception of the 3 month duration, none of the longer maturities declined in yield over the past nine month, even as the Fed lowered interest rates.

And since the start of the war with Iran, all of the longer maturities have increased in yield by about .5%, as shown in the below close-up of this year:

The same dynamic has caused mortgage interest rates to rise to a new nine month high as well, which will not help the already recessionary housing market:

The emerging economic dynamic, to paraphrase Mark Twain, won’t repeat the inflationary 1960s-70s, but it likely will rhyme. Showing how that is likely is a little difficult with graphs, but bear with me.

Here are two graphs, of the 1960s and 1970s, showing (1) the increase, in percent, of the 10 year US Treasury (*10 for scale), in blue. If in a given quarter the average yield increased 0.5%, that is shown as +5% in the graph. Also in the graphs are the nominal (gold) and real (red) quarterly percentage change in GDP:

Here is what I want to direct your attention to. Inflation and the secular increase in interest rates began to take off in the mid-1960s with LBJ’s “guns and butter” stimulative economic policy. Thereafter, as interest rates and inflation both increased in any given quarter, in real terms growth in GDP was likely to decelerate or even decline. Thus, for example, in the fist part of the 1960s real GDP growth averaged about 2% annualized, but after the middle of the decade tailed off to about 1% annualized with the exception of the first two quarters of 1968. Similarly, in the 1970s real GDP growth approached 0% in most quarters where there was a significant increase in bond yields.

I expect a similar secular dynamic is beginning to take hold now. And it will likely last throughout the next decade or so. On a long term basis, bond yields tend to follow a cycle which lasts approximately one average human lifetime (i.e., polities are most likely to forget the historical lessons and repeat the same historical mistakes that they have not lived through). In the case of the US, there was a cycle that began with an interest rate peak coincident with with Civil War and lasted until 1920:

Then there was a second cycle that began in 1920 and ended in about 1981:

And we are currently living through the next cycle, that began in 1982 and made its trough in the last decade:

As I’ve noted elsewhere, the Founders’ generation, like the political theorists of earlier times, worried that in a democracy the masses would likely simply vote themselves money out of the Treasury. What they did not foresee was that the very wealthy would put together a victorious coalition and then vote *them*-selves money out of the Treasury.

I cannot say what will happen with bond yields in the next day, month, or year. But the evidence is clear and convincing that an inflationary secular trend of rising interest rates is here.

What’s driving the stock market Boom (or Bubble)?

 - by New Deal democrat

In the past month or two, a number of times I have been asked by friends and neighbors why, if the economy feels so bad, does the stock market keep making new record highs? And is this a Boom or a Bubble?

Here is what I have been telling them.

There are two current drivers of the stock market: (1) AI data center related spending, and (2) domestic energy company profits.

Let me tackle the second one first, because it is relative simple and straightforward. As we all know, the Strait of Hormuz, through which most of Middle Eastern oil flows, remains closed. But the Gulf of Mexico is wide open! And that means that countries and companies that need oil are bringing their empty tankers to Gulf Coat ports and loading up. US oil exports have thus hit a new record:

Further, because the price of oil is set globally, they are loading up at that price. Which means that domestic producers like ExxonMobil and Chevron are making out like bandits:

So while consumers may be suffering at the gas pumps, US based producers most certainly are not.

Now let’s turn to AI data center related spending. Below are three components of industrial production that are tied to AI data centers: semiconductors (blue), computer and electronic products (orange), and electric and gas utilities (gold, right scale):

All three have increased much more than industrial production as a whole over the past several years, particularly semiconductor production, which is up over 60%! As I have written before, once you take out AI related spending, manufacturing and production have gone basically nowhere in the past several years.

So, in answer to the first question, these two sectors are what have been driving the stock market higher.

But is it a (sustainable) Boom, or an (unsustainable) Bubble?

To give you my sense of that, I have to get into the weeds on some data I don’t normally concern myself with, which are called “stock market internals.”

Last week I wrote that half of all S&P 500 profits have come from just 5 companies:

That’s not exactly a widespread Boom.

Next, here is an update of a stock market indicator I touched on a few times last year: the advance-decline line. This tells us how many more stocks are increasing in value than decreasing. If the economy is doing well, such increases ought to be widespread. But if only a few companies are advancing, that tells us that the majority of the economy is not doing so well. Here’s what that looked like late last year when I wrote about it:

And here is what it has looked like so far this year:

While compared with last year, there has been an increase in the total number of advances vs. declines, in the past month this number has fallen fairly sharply, back to where it was in February, and only a little better than late last year.

A similar lack of widespread health is shown by the number of new highs vs. new lows in stock prices:

In the recent advance, only a few more stocks made new highs than made new lows.

Finally, let me touch on one other measure of relative health: the stock vs. bond dividend gap. This is the difference between the amount of dividends paid on S&P 500 stocks, vs. the interest rate an investor can get by holding bonds. The higher the gap, the more investors are relying on stocks rising in prices to cover their risks.

And to start with, the S&P 500 is at or near record low dividend payments, at only 1.06% of their price:

Dividends on the S&P 500 have generally drifted lower for decades, but at least during 1981-2020, so did interest rates on bonds.

So here is how the current dividend yield on the S&P 500 compares with the yield on a 10 year Treasury, currently at about 4.5%:

And here is the same comparison with the 2 year Treasury note:

Both of these measures are at their worst levels for stocks since before the Great Recession 20 years ago.

Finally, here are the yields on AAA and BAA investment grade corporate bonds:

These are at levels equivalent to just after the Great Recession. Put another way, you are currently being paid about 3.5% more than S&P 500 stock dividends to own a 10 year Treasury, about 4.5% more to hold an AAA rated corporate bonds, and about 5.0% more to own a BAA investment grade bond. All to bet that the stock market will continue to increase in price in the next year. 

This does not tell us in *absolute* terms whether stocks or bonds are a “good” deal. What it does tell us is that in *relative* terms, you are taking more risk than at any point in the past 20 years to gamble on stock price appreciation making up for the puny dividends you are earning on them. Bonds could still be a bad deal at present — but stocks are relatively speaking at far more risk.

The present situation reminds me very much of 1999, when the advances in the stock market were focused on the dotcom issues. But the advance decline line deteriorated for about a year before the dotcom implosion kicked in. 

So my conclusion is that, at the moment, the momentum in the AI sector, joined by the windfall profits for domestic oil producers, are more than outweighing the difficulties by most consumers. But that momentum looks extremely risky. Like a bubble.

 

Weekly Indicators for May 11 - 15 at Seeking Alpha

 

 - by New Deal democrat

My “Weekly Indicators” post is up at Seeking Alpha.

Unsurprisingly, the big move among the high frequency indicators in the past week was interest rates. There was also a secondary big move, which is also inflationary, and reflects the ongoing idiocy of the current Administration in Washington: international shipping rates spiking, in one case to a 24 month high.

As usual, clicking over and reading will bring you up to the virtual moment as to the state of the economy, and toss me a penny or two towards my next outing for lunch.