The outlook for housing (or more precisely, sentiment about the outlook for housing) has improved in recent weeks, primarily because of the decline in mortgage rates. The average rate on the 30-year mortgage has fallen by 57 basis points (bp) since mid-November from a peak of 4.94% to 4.37% last week (as of Feb. 14), according to Freddie Mac. That should bring more entry level buyers back into the market during the peak spring selling season which is just now getting underway. Improving sentiment can be seen in the latest reading of the NAHB/Wells Fargo Housing Market Index, which rose four points in February to 62, better than consensus expectations of 59. Since consumer confidence remains fairly high, there is a chance that house sales could bounce back sharply, if buyers rush to avoid missing out a second time.
For now, though, the data (which is backward looking) confirms that the housing market has been slowing. The seasonally-adjusted annual pace of new home sales declined by 7.7% in November (the latest date for which information is available thanks to the Federal government shutdown in January). November new home sales rebounded fairly sharply from October (which was a surprise) and the figures for the immediately preceding months were revised higher. But except for the November blip, new home sales were in a clear downtrend in 2018.
For all of 2018, with the stronger year-over-year gains posted in the first half of the year, new home sales will probably eke out a small gain of perhaps 1% versus 2017.
Existing home sales also confirm the slowdown. The seasonally-adjusted annualized pace of existing sales in December fell 10.3% from the prior year to just under five million units, according to the National Association of Realtors. For the full year, actual sales (which are still subject to revision) were down 3.1% to 5.511 million units. The median existing home price increased 2.9% in 2018, the slowest in seven years.
Despite declining sales, housing production has held up reasonably well and inventories, after the November rebound in new home sales, remain in relatively good shape.
The seasonally-adjusted annualized pace of single-family housing starts was down 10.3% in November, against an unusually strong prior year level; but like new home sales, SF starts will end the year up a couple of percentage points. November single-family permits were down only 1.9% from the prior year and were up 5.2% year-to-date; so full year 2018 SF permits will probably be up at least 3%-4%.
New orders for the homebuilders continued to fall during December, as reflected both in the builders’ fourth quarter earnings reports and also in the declining sentiment expressed through the NAHB/Wells Fargo Housing Market Index. But the HMI bottomed in December and improved in both January and especially February, as mortgage rates continued to fall. All components of the HMI – the current sales pace, expected sales pace six months out and current buyer traffic – showed solid improvement in February.
This suggests that 2019 first quarter orders should be substantially less negative – and perhaps even slightly positive – against strong 2018 first quarter levels, compared with the average 8% decline in orders reported so far for the 2018 fourth quarter.
The increase in the HMI portends a better-than-expected spring selling season for the housing market. This is also reflected in the rebound in homebuilding stocks that has taken place over the past few weeks, reversing the sharp downtrend that was evident for virtually all of 2018. (As noted in my previous housing update, that rebound in homebuilding stocks preceded the rebound in the broader market.)
This rebound in the homebuilding stocks looks like it has legs. Even after the recent bounce, the average homebuilder stock, according to my calculations, is trading at only 9.3 times consensus 2019 estimates and 8.8 times (consensus) projected 2020 earnings. Those estimates anticipate that earnings will fall 8.6% in 2019, but rebound 7.4% in 2020.
With a stronger-than-anticipated spring selling season, the decline in 2019 earnings could very well be lower than projected, which would support an increase in the forward multiple to perhaps 11-12 times. That would give the homebuilding stocks 20%-25% upside from current levels.
If that happens, one of the bigger questions following such a move will be “what comes next?”. The answer, of course, is that it depends on what happens to mortgage rates later in the year and beyond. That, in turn, may very well depend upon the actions of the FOMC.
Following its decision to pause in its quest to normalize interest rates, yields on intermediate- and longer-maturity Treasurys have moderated, leaving the yield curve just about as flat as it can be through five years.
For now, this moderation in rates has helped spark the broader rebound in stocks and bonds. The financial markets are pleased that the Fed has been able to normalize interest rates (at least so far) without derailing the economic recovery. As I have noted, the decline in mortgage rates since November helped spark the improvement in the outlook for housing and the recovery in housing-related stocks.
If it does turn out, however, that housing ends up being stronger (let’s say much stronger) than anticipated as a result of low end buyers rushing in to avoid missing their chance to own a home, then it could put the Fed in a quandary, especially if the rebound in housing contributes to stronger-than-expected economic growth.
While I think that a case can be made that the Fed Funds rate has already been normalized at the current target rate of 2.25%-2.50%, that conclusion assumes that inflation remains in or near the Fed’s target rate of 2%. If, on the other hand, inflation rises meaningfully above the 2% level as a result of a stronger economy, the Fed will be pressured to raise the benchmark rate further. The question will then be whether the economy – and especially housing – are strong enough to handle higher rates. In 2018, we found out that the housing market struggled as mortgage rates approached 5%. It would probably be surprising to get a different answer in 2019 or 2020.
February 20, 2019
Stephen P. Percoco
Lark Research
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