Inventory buildup came to a halt in the first quarter of 2017 reflecting a near one percent reduction in U.S. Gross Domestic Product (GDP) estimates. While we assume the pullback to be temporary, overall growth was also mediocre. According to the same advanced estimate released by the Bureau of Economic Analysis, U.S. GDP increased at an annualized rate of only 0.7%.
Even so, we remain constructive on the U.S. economy. For one, first quarters have historically fallen short. Additionally, forward-looking indicators signal acceleration in the 2nd quarter. The International Monetary Fund (IMF) expects the U.S. economy to average 2.3% growth in 2017 and 2.5% in 2018, and surveys of professional forecasters indicate a similar take. Given the strength of recent indicators and the potential for fiscal stimulus, we believe the U.S. economy is more likely to outperform current forecasts for 2nd half of 2017 and 2018 than it is to underperform.
Perhaps even more important, is recent data reaffirming the U.S. housing recovery’s strength. Existing home sales and new home sales rose to new highs up 5.8% and 4.4% respectively. So, despite a sharp one percentage point rise in mortgage rates, the longer-term upward trend in housing continued to strengthen (figure 1).
Admittedly, it is unlikely that we see the sort of growth in housing during the current economic expansion as we have seen in decades past. For one, population growth is slowing. For another, household-formation and homeownership rates are historically low. But remember, those who are ‘of age’ to buy a home may be hesitant given fresh memories of the mortgage crisis and student loans which weigh on their pocket books. This age cohort is also working on a different timeline than preceding generations. They are late to marry, late to have kids, and also may just be late to buy a home.
With or without their participation, a real recovery in housing seems likely to continue. Very low unemployment and rising wages provide the backdrop to housing demand. The balance between rent costs and housing costs steer incentives in favor of home ownership. And the historically low overall ratio of mortgage debt to disposable income signal ample room for housing to grow (figure 2).
But why do we as investors care so much about housing? The answer is rooted in three simple economic concepts: the wealth effect, the income effect, and a multiplier effect.
As home prices rise, existing homeowners will begin to feel wealthier as their assets grow in value. When households feel wealthier they will likely spend more. And so, homeowners, who could afford their mortgage, will feel wealthier and begin to spend more money. Meanwhile, others, who are able, will want to reap these same benefits of home ownership.
Once the excess supply of housing is absorbed, then new home construction can begin to ramp up to normal levels, leading to jobs in construction as well as all of the industries that supply raw materials, goods, and services to the housing construction industry. The increased demand for workers puts upward pressure on wages. So long as real incomes rise, so does the ability to consume goods and services.
And finally, new owners tend to spend a substantial amount of money on things like realtors and moving companies as well as appliance and furniture to outfit their homes, an additional source of demand for goods and services. According to a pre-crisis study by NAHB, the average home buyer spends 2.8 times more than the average non-mover on goods and services in the year period following the move.
The U.S. post crisis recovery is deeply rooted with problems intertwined between the housing sector, banks, corporate, and household balance sheets. Almost ten years later, frustration with the slow recovery has led many to question its soundness. A continued pick up in housing for us is another indicator that the private sector deleveraging cycle is nearly over, and another signal that this recovery has room to run.
By Jae Yoon, CIO, New York Life Investment Management
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