Written by: Tim Pierotti
Wall Street pundits love the Mark Twain quote, “History doesn’t repeat itself, but it often rhymes”. Well sometimes it doesn’t even rhyme. There is no precedent for the current US housing market. We’ve never had a fed tightening cycle when so many Americans with mortgages were locked into rates far below where they are currently settling out. The “Golden Handcuffs” of the American homeowner forever attached to their home and 3% mortgage is all new. Economists like precedent, previous cycle correlations that could prove prescient. We have nothing in modern economic history to help us understand how long the supply issue could last. But the story isn’t just a lack of supply. Look at the persistence of demand in the face of mortgage rates going from the high 2’s to the high 6’s. Affordability rates (as illustrated below from Ed Yardeni) have persisted at levels worse than the years preceding the housing collapse during the Great Financial Crisis. We have to go all the way back to the Reagan administration when rates were still in the teens to find a time when affordability was worse. And yet, the housing market plods along. Home prices nationally rose 38% on average since the beginning of the pandemic. While activity is down significantly given the lack of existing home liquidity, prices are only down roughly 3% from the peak.
So how does it play out from here? Let’s walk through the likely pressures and tailwinds going forward. Below is a chart from Apollo’s Torsten Slok that illustrates average mortgage payments on newly purchased homes have doubled in less than two years. At some point, we have to assume that this will lead to some “crowding out” of other consumer spending.
On the other hand, the labor market is also tight in an unprecedented manner driving wages higher at a rapid clip and that undoubtedly is driving some of this. Also, “The Great Wealth Transfer” is likely having an impact as baby boomers and those of the silent generation bequeath wealth to younger generations who use that money to buy houses. Remember, while the savings rate of the average American is weak, accumulated savings spiked with the massive fiscal and monetary liquidity gusher and that will have a lasting impact.
Prices have held up so well and demand remains so robust that now despite higher rates, builders are again ramping up starts as illustrated in the chart below. As long as the existing home market remains tight, builders enjoy strong pricing while materials costs like lumber have declined materially.
One simple answer to how does all this end is: The Fed is pushing us slowly but surely into a recession and then we will see incomes fall, demand and pricing will fall and sellers will capitulate. But if we do have a recession, it is likely that mortgage rates will come down which will serve to ease affordability. Additionally, lower rates will help to remove the golden handcuffs as giving up the 3% mortgage becomes relatively less painful. So, while a recession would likely improve liquidity, it isn’t clear to me that a shallow recession would have a meaningful impact on prices given the benefit from lower rates.
So where do we shake out on the question of housing? My best guess is that we continue to muddle along with continued slight downward pressure on prices and continued weak overall turnover. The new home market likely remains relatively robust as it will enjoy the high price umbrella of the supply constrained existing inventory.
Like so many aspects of the US economy, the longer-term outlook for housing will come down to whether or not we face structurally higher inflation volatility and higher long-term rates. As I said above, in a recession, rates across the curve are likely to come down, but what about beyond the immediate cycle. Our core view at WealthVest is that the multi-decade era of falling interest rates and quiescent inflation are behind us. The US and developed world worker shortage is real and it is enduring. The drivers of which are age demographics and deglobalization/protectionism that are not projections, but they are a reality. Additionally, we are concerned that our structural deficits and fiscal profligacy will likely also lead to higher rates. If we are right on our secular inflation view and mortgage rates remain higher for longer it would make sense that there is some mean reversion to affordability which means that prices may have made a high-water mark for a very extended period of time.
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