We saw weak leading housing indicators being released late last week and it feels like we are at a crossroad for the housing market. So far, the seasonally adjusted national housing index is still in an upward trajectory, but there are several concerning signs which I wanted to discuss in this article.
Figure 1 - Source: St. Louis Fed
During the last downturn, we clearly saw leading indicators like housing starts and building permits turning down well ahead of house prices, at least on a national level. I am not predicting anything of that scale this time around, but the next few months will likely clarify the state of the housing market.
It is important to point out that most house price indicators used today are seasonally adjusted. This is most often to the benefit of the end user, to exclude seasonal fluctuations. Having said that, it also has the potential to obscure changes during turning points. Before the global financial crisis, we had the non-adjusted national price index peak during July of 2006 already. The more commonly used seasonally adjusted index peaked during February of 2007 first.
The below chart highlights how poor the leading indicators had already become at the time of the turning point, February of 2007. Everything is always easier with hindsight, but the below graph does a good job by illustrating how lagging national seasonally adjusted house prices can be.
The below chart looks at the non-adjusted S&P/Case-Shiller price indices on a national level and some of the more extreme markets. The more extreme markets have turned down on the seasonally adjusted level as well, while that is not the case on the national level. The seasonal adjustments have worked in favor of the indices over the weaker winter months, but for the coming 6 months, the adjustments will work in reverse. This will be the true test of the housing market.
Figure 3 - Source: St. Louis Fed
U.S. median sales prices for new houses sold peaked in the end of 2017 already and has been in a downward trajectory for over a year now.
Figure 4 - Source: YCharts
We are also seeing some housing markets globally starting to decline. This is the case for many countries where the global financial crisis had a more minor impact on the local real estate market like Australia, Canada, and Sweden. The direct impact from this on the U.S. general real estate market is likely relatively low, but global weakness could have some impact to the more excessive U.S. markets where foreign investors are more active. This in turn can have contagious effects.
The below chart looks at 12 months change on housing starts and building permits where Friday's housing starts is the weakest annual change since the global financial crisis. We have now seen 6 consecutive months of year-on-year declines for housing starts. The numbers for building permits are not on a decade low, but they are also relatively weak.
The 30-year mortgage rate has come down significantly over the last 6 months which has yet to translate into more activity in the leading indicators. It is also important to look further back, rates are now still above levels seen a little over a year ago.
Figure 6 - Source: YCharts
On the 20th of March, the Fed announced that the balance sheet reduction on an aggregated level will end during September of 2019. However, it was also communicated that the Fed does not intend to hold MBSs over the long term and some MBS principal payments will be reinvested in treasuries. In summary, quantitative tightening will continue to be in effect in the MBS market. What the Fed predicts in the long term should be taken with more than a grain of salt, but it does have the potential to be a headwind for the housing market in the short term.
Figure 7 - Source: The Fed
I think the housing market is presently at a crossroad where the probability of a decline is relatively high. If there is a decline, it will likely be less severe compared to what we saw during the global financial crisis, but the market seems to price this probability as extremely low judging by the recovery in home builders.
Figure 8 - Source: YCharts
The next 6 months will be very telling as the seasonal adjustments will decrease the adjusted numbers, so rather than mask a potential decline, it can accelerate it. The leading indicators point towards a slower housing market. Some markets feel like they have gone to extreme levels, where a reversal is natural. This together with a slower global environment has the potential for knock-on effects in the general markets. The MBS market will also continue to see an increased supply unlike the treasury market where the Fed will be in easing mode.
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.