Trend In Housing Permits And Starts Turns More Negative

Summary

• Housing permits in particular are an important long leading indicator.
• All forms of permits and starts made peaks between 6 and 8 months ago.
• Total permits and starts are both sufficiently lower for a sufficiently long period of time from their peaks to warrant downgrades.

Introduction

Over the last year, the big question has been how increased interest rates and ever-escalating prices may finally be taking a bite out of the market. In order to examine this, and to put this morning's report on housing permits and starts in context, let me first step back and give you a "big picture" look at housing data - because there is a pattern to the order in which housing trends change.

That order is as follows:

• interest rates lead sales
• sales lead prices
• prices lead inventory

I don't mean to suggest that the above sequence is inviolable, nor that causation is singular. It is clear, for example, the demographics has an important effect. But as I have pointed out in the past, even if prices that are "too high" cause sales to slump, sales will turn first, even as prices rise for a while.

2 months ago, I summarized the state of the housing market as having turned slightly negative, with housing starts and permits the sole remaining weak positives.

Last month they too went negative, in what I called probably the most significant single housing report in the last 6 years. This month's report for September continued the negativity.

Permits turn negative

Because permits tend to follow mortgage rates with a lag time of about 6 months, and mortgage rates had increased over that time, I wrote that the issuance of permits should stagnate.

With that in mind, here's an update graph of mortgage rates (inverted) and permits (red/10 for scale) for the last 6 years, showing the relationship:

There were some significant revisions of recent data, but the negative trend remains intact. Here's the bullet-point version as shown on the graph below:

• Single-family permits (red, right scale) did improve month over month are up +2.4% above last September's easy comparison, but are still about 3.5% below their February peak, and tied with March for the 3rd worst reading in the past 12 months.
• Total permits (blue, left scale) came in at yet another 12-month low, are down -1% YoY, and down -10% from their March high. This is recession watch territory.

I focus on single-family permits because they are the least volatile of all the housing data, and are just as leading as permits overall (first graph below) and slightly more leading than starts. They are also "much" less volatile than new home sales, which are also very heavily revised.

While the news in permits was poor, this hardly means that a recession is around the corner. It has always been the case for the last 50 years that housing permits, both total and single-family permits, turn negative significantly before a recession hits:

For the second month in a row, total permits are negative YoY. But single-family permits are still up 2.4% YoY.

Further, before a recession hits, total permits typically decline by at least -200,000 units, and single-family permits decline by at least -150,000 units:

As of September, total permits were down -136,000. Single-family units were only down -35,000 from their peak.

Finally, it bears repeating that, because these are both long leading indicators, they typically peak at least 1 year before a recession hits.

Last month I switched the reading on permits from positive to neutral. Now that both single-family and total permits have gone 6 months (7 in the case of single-family permits), and because total permits are 10% off their peak, I am downgrading them to a weak negative, with the sole silver lining that single-family permits improved to less than 5% off peak this month.

Starts turn from weakly positive to neutral

Turning to housing starts, they are more volatile and tend to lag permits by about a month. This month they indeed followed last month's permits by turning south:

Because of their volatility, the 3-month moving average is the best way to view this metric, and so doing, they improved slightly over last month. But that just means they are at the second lowest level in 10 months.

But starts are still positive YoY. Further, starts have generally declined by -400,000 before a recession has begun:

We remain nowhere near meeting that criteria, but on a monthly level, we are 10% off the peak (revised from 6) 8 months ago, and 1/3 of the way to that level. Because of this, a downgrade of housing starts from a weak positive to neutral is in order.

Conclusion

The second poor month for housing permits and starts changes the ratings of the 7 housing indicators to the following:

• NO positives
• 3 neutral metrics (nominally measured private residential investment, housing starts, and as of this morning purchase mortgage applications), and
• 4 negative metrics (real private residential investment, new and existing home sales, and now housing permits).

The overall state of housing is still nowhere near recession watch status. But my suspicion is that the Q3 GDP report next week will include bad news for private residential fixed investment. If so, that will turn yet another metric negative.

Meanwhile, mortgage rates rose to yet another new 7-year high over 5% last week. The increase that began in March is now showing up in housing. Unless these mortgage rates abate, the issue I mentioned at the beginning of this article appears to have been settled: we've seen the peak for housing in this business cycle.

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.