Last week, I wrote that as to *sales,* “Housing has bottomed.” Every indicator but one - overall housing permits - has rebounded off their respective bottoms in the past six months, including new and existing home sales, starts, and single-family permits.
If we needed any further confirmation, this morning’s release of pending home sales, which leads existing home sales by one or two months, rose as strong 1.8% monthly. Here’s what the longer term graph looks like:
As I wrote last week, chronologically, interest rates lead sales, and as interest rates have declined by 1% since last November, housing sales touched bottom and have turned higher.
Prices are still reacting to the 2018 downturn in sales
But even though there is a feedback mechanism between house prices and sales, the fact remains that chronologically, sales lead prices. It takes time after sales turn higher or lower that sellers and buyers learn that conditions have changed.
So it ought to be no surprise that both the FHFA house index last week, and the Case Shiller indexes this morning, continued to show decelerating price increases. Here’s what they look like (blue and green, respectively, left scale) vs. single-family permits (red, right scale) in absolute terms. Note that I’ve normed the price indexes to 100 as of June 2011, because that is the month, according to Sentier Research, that median household income bottomed:
It is easy to see on this graph that permits made both peaks and a trough before either measure of house prices.
Now here is the same data measured as YoY% (permits/2 for scale):
It is very easy to see on the above graph that the YoY% change in permits made peaks and troughs in advance of prices. While the lead time is variable, generally it is in the neighborhood of six months. Since single-family permits were at their worst reading YoY in April, this suggests that the price deceleration in houses will continue before beginning to abate roughly in autumn.
Which brings me to the concept of a “choke collar” in housing
About 10 years ago, I employed the same concept to gas prices. So long as prices changed slowly enough, it appeared that there was a “choke collar” at roughly $4/gallon. Below that, the economy continued to improve - leading to more demand for gas. Above that, gas prices constricted the economy - leading to less demand. The $4 gas price served as a governor constraining the economy.
The same thing may be happening with housing. To show you why, let’s compare median household income with both the FHFA and Case Shiller house price indexes. The graph below norms all three measures to 100 in 2012. All are measured nominally:
Since that time, median household income increased only 20% through its last official annual measurement in 2017. But house prices increased about 35% through that year, and are up over 40% through Q2 2019. While house prices aren’t quite at their bubble peak premium over incomes at this point, they’re getting there.
Fortunately, Sentier Research uses form BEA economists to put out a monthly update to median household income. It was just released this morning for June:
According to the Sentier’s accompanying press release, as of June, nominal median household income is up 6.0% above the end of 2017, and 1.8% YoY. Meanwhile, the FHFA Index remains up 5.0% YoY, and the Case Shiller National Index up 3.5% YoY. Quite simply, house prices are outpacing household income.
There is no relief in renting either. CPI for the rent of one’s primary residence is up 3.9% YoY:
It is up 30.9% since June 2011 - again, a bigger increase than median household income.
Another measure, median asking rent from the quarterly Homeownership and Vacancy report is up 6.0% YoY:
In summary, while declining interest rates are driving down monthly mortgage payments, price and rent increases in excess of incomes are exerting a countervailing force. That rents are also increasing in excess of income is detracting from rental’s ability to be a pressure release valve. And the more demand for housing increases via increasing sales, the higher the price pressure for houses will be.
On top of that, if the Fed lowers rates to help boost the economy (or keep it from slowing down too much), interest rates including mortgages may begin to rise again. While it is certainly speculative, there is at least some evidence that, for now, long-term interest rates have also bottomed:
With house prices at least approaching their bubble peak as compared with household incomes, and with rents, relatively speaking, higher than that, housing appears to be in a choke collar that will constrain its ability to lead to meaningfully higher economic growth over anything more than a limited period of time, even though sales appear to have bottomed.
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.