Will US Housing Crash The Economy?
Maybe it’s different this time.
Could US Housing Crash The Economy?
I’ve realised that one of the phrases I use most in this email is “no one has a crystal ball.”
I’m not going to stop doing that. I think it’s important for us all to remember that forecasts are often wrong (just ask the UK’s Office for Budget Responsibility — boom boom!) and talk is cheap.
One thing I will say, though, is that the current environment is less conducive to having strong conviction than almost any other I’ve worked in.
In the long run, the view I have the most confidence in is that we’ve now escaped the era of “secular stagnation” and that the foreseeable future involves wrestling more with inflation than with deflation.
Inflation will have its ups and downs and we might even see negative prints at some point (spiky prices and maths combine to create those sorts of things). But in the longer run, I think the underlying trends all point in the direction of more rather than less inflationary pressure.
I actually think this is a good thing as it will inject some urgency and some discipline into our capital allocation process. When capital is cheap and easy to get hold of, bad ideas thrive because they involve less work than good ideas.
It’s easy to build a business selling £10 notes for £5 a piece, and telling low-rate-addled investors that it’s all about “building an audience.” It’s hard to build something that might actually be both useful and profitable, and that has clear criteria for success or failure.
So the more demanding environment is a good thing. Resources will flow from those bad ideas that can only survive in a low rate environment, to the good ideas that can survive or even benefit from higher rates (“anti-fragile” as Taleb might put it).
Put simply, necessity is the mother of invention.
Will US Housing Crash The Economy?
So that’s the long run. I might well be wrong, but my conviction in that outcome is pretty high.
But as for the short-to-medium term — I’ve no idea. Will we have a recession? A full-on crash? Or a boom period? I’m not sure. The economic indicators are all over the place.
So I’m keeping an eye on interesting ideas from thoughtful commentators. Here’s one from the bearish end of the spectrum that caught my attention today: Dhaval Joshi from BCA Research’s note about the state of the US housing market.
The US housing market is different to the UK’s in lots of ways, but the important one is mortgage length. In the UK, mortgages are relatively short-term. Few people go beyond a five-year fixed-rate loan (although we’re not Sweden, where virtually everyone is on very short-term variable rate loans — hence last year’s housing market slump).
In the US, by contrast, mortgages are virtually all 30-year loans. You take out a mortgage at one rate, and you can keep it for good, or if interest rates go down, you can refinance. It’s a one-way bet for consumers, which has led to some wags pointing out that the US is the only country in the world with a socialised mortgage market and a privatised healthcare system.
Anyway, this has some interesting side effects when interest rates go up. Existing homeowners can rest easy on their 3%-or-so fixed rates. But new buyers can only borrow at rates closer to 7%.
That has one clear result — if you are a builder of new homes, you are not going to be able to fetch anything like the price you might have assumed, because your customers simply won’t be able to borrow enough money. What do you do? Well, you stop building.
Joshi’s point is that home building activity has dropped by 20% in the past year. That speed of decline puts it up there with five other big US “housing recessions” — 1990, 1980, 1973, 1965, and 1951.
Why does that matter? Because, notes Joshi, most housing recessions precede recessions for the whole US economy. This is logical. Housebuilding is highly interest-rate sensitive, and so it keels over before the rest of the economy does.
“If the perfect post-1970 track record continues, the current US housing recession is the canary in the coal mine for an economic recession that starts at some point in 2023,” he wrote.
Joshi’s conclusion is that investors should be positioned defensively — favour bonds over shares; healthcare (defensive) stocks over technology (growth) and basic resources (cyclical) ones; and developed over emerging markets (the latter are more vulnerable to a stronger US dollar). Will US Housing Crash The Economy by Photographer: Daniel Acker By John Stepek.
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