Can Real Estate Cause Another Slowdown In GDP?

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Includes: IYR
by: Charen Investment Research

Summary

Core CPI still includes housing.

After a severe contraction after the Great Recession, housing is gaining once again.

A rate hike with slow wage growth can prove a disaster for the economy.

In my recent article 3 Charts About Inflation We Cannot Ignore, I focused on inflation and its effect on GDP. In this article, long-term US growth will be of focus.

To be clear, this article is less about real estate and more about how real estate affects the most commonly used inflation indicator, the Core Consumer Price Index (CPI ex energy and food). Core CPI is cited by the FED as an integral view into the health of the economy - if it is meeting its target, than the US is on its road to healthy growth. The problem is that targeted Core CPI walks a thin line.

As of now, the FED targets 2% inflation growth. Taken from their website, they believe that this target "is most consistent over the longer run with the Federal Reserve's mandate for price stability and maximum employment." Anything more than two percent is a rapid movement that can cause a quick rise in interest rates and lead to a large recession - similar to what is occurring in Brazil right now. On the other hand, if deflation occurs, the USD can become too strong and once again lead to a terrific slowdown. In fact, because of the strong US dollar, Goldman Sachs Global Investment Research has predicted a large slowdown in trade:

According to economic theory and depicted by this chart, exports are declining sharply. Higher relative value of currency causes countries to shy away from business with the US, and instead do business with those countries with cheaper currencies. Important to note, the biggest decline in the slowdown is featured in Q3 2016.

Here is another graph provided by GS GIR:

The slowdown in exports has a meaningful effect on overall GDP, once again with the biggest decline of all in Q3 of 2016. Now, while slowing growth is always dangerous, it is real estate that is a prime culprit for an even greater decline. This is because the housing market is featuring incredibly strong growth. Incredibly strong growth, however, that is unsustainable.

As the markets have learned over time, real estate is and will continue to be a cyclical market. Thus, its effect on US GDP and Core CPI must be viewed in cyclical nature as well.

Above is Core CPI from Q2 2005 until Q3 of 2015. Since 2012, the US economy has been in a period of disinflation. A Federal Reserve leak hasn't helped to stymie the fear that this will be an ongoing problem. The problem however, is that housing is practically holding up Core CPI on its back:

Here is a chart of personal consumption expenditures since 1990. Without housing, and similar to Core CPI, the gradual decline in spending growth since 2012 is much more apparent - falling almost another 100 basis points.

And if you were wondering how much consumption growth is as a percentage of GDP growth, take a look at this chart featuring Q2 2015 GDP:

A stronger USD and any sign of a decline in the housing market will take a large chunk out of the 'Consumption' contribution to US GDP. Rising rates only increase this risk. With consumption making up over 75% of GDP growth, raising rates with the intention to help the health of the economy can actually do the opposite.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.