The U.S. housing market is a bright spot for the economy, yet when March housing starts fell, it briefly took some market watchers by surprise.
Several economists brushed aside the weakness in housing starts as weather-related.
“This was likely due to weather-related disruptions from Winter Storm Stella,” says Joseph LaVorgna, chief U.S. economist for Deutsche Bank in New York. “The fact that building permits were up 3.6 percent (in March) indicates that the uptrend in housing remains firmly intact.”
Kristin Reynolds, economist at IHS Global Insight in Boston, says when looking at strong March new home sales, regional results show trends improving everywhere.
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“All regions are trending well ahead of a year earlier, led by the Midwest,” she says, adding the numbers lead them to believe the number of new homes going under contract in 2017 could be the best annual pace since 2007.
In general, most economists and market watchers still see the housing market performing well, but they are keeping an eye on a few factors, such as rising prices affecting affordability, rising interest rates and the general U.S. economic outlook for signs of any downturns.
Fundamental strength bodes well. LaVorgna says there are several factors favoring a firm 2017 U.S. housing sector. A healthy household balance sheet, job growth and looser residential lending standards give the sector a firm footing, along with tight supply of existing homes for sale.
“In fact, residential investment as a share of nominal output remains depressed relative its longer-term trend,” he says. “With levels of both homebuilder and consumer confidence at post-recession highs, we expect the housing sector to contribute positively to overall economic output this year.”
Pat O’Hare, chief market analyst at Briefing.com in Chicago, says the outlook for the housing sector is still positive.
“You have rising employment. You have a pickup in income growth, albeit not as much as you’d like to see, it’s still picking up,” O’Hare says. “You have the persistence of relatively low interest rates. Yes, they picked up since the election, but they’re still really low, all things considered. You still have a semblance of pent-up demand, really. So those are all good things.”
Yet Suzanne Hutchins, London-based global investment manager at Newton Investment Management, part of BNY Mellon, says people looking at the U.S. housing market need to keep a few factors in perspective.
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Her team believes the U.S. economic cycle is closer to the end than the beginning, noting it’s been several years since the last recession. And with interest rates going up, even from very low levels, that will likely mean a slowdown in housing.
“We have seen evidence of mortgage applications declining when the 30-year Treasury borrowing rates have increased above 3.10 in terms of yield,” Hutchins says. “Any sort of yield increase does cap the rate of borrowing and the ability of individuals to pay for mortgages.”
Further, she says, considering the context of the current environment where asset values are up across the board, whether it’s housing, stocks, bonds or alternative assets, she considers the economic backdrop as “quite fragile.”
What’s limiting growth. O’Hare says two related factors may limit the housing sector, supply and price. The supply of existing home sales is lower, and that’s caused home prices to rise at a much faster rate than income growth.
“It points to affordability constraints,” he says. “That’s a major headwind for housing. What’s really important given that dynamic is that interest rates remain low. If you were to get a big jump in mortgage rates, that could put a brake on the market because it would most likely sap demand at this point because income is not keeping pace with home prices.”
O’Hare says to watch for how many times the Federal Reserve raises interest rates this year and the pace of those increases. Mortgage rates are down slightly from 2017’s peaks, but they are expected to creep up by the end of the year, according to Bankrate.com.
“When you get these higher mortgage rates, you’re going to run into some constraints for the housing market,” O’Hare says. “A lot is going to have to do with the pace with which those rates go up, if and when they go up.”
Equities reflect strong housing. Several companies tied to the housing sector are benefiting from the strength, O’Hare says. For example, iShares U.S. Home Construction exchange-traded fund (ticker: ITB) is up 18 percent this year. Firms connected to home improvement like Home Depot ( HD), Lowe’s Companies ( LOW) and even smaller companies like Mohawk Industries ( MHK) have also fared well.
Part of those gains come from the overall strength in the U.S. stock market, which is up based on ideas the economy will improve because of unspecified pro-growth initiatives of the Trump administration, he says.
Hutchins says while central banks and policy makers are looking to underpin the economy with potential changes in regulation and tax reform, they don’t address the real issues.
“It doesn’t address the stronger, longer structural issues of the economy such as demography, aging populations and (significant government debt),” she says.
With very high stock valuations, investors need to watch for changes in market attitude. O’Hare says if tax reform doesn’t happen or takes longer to happen, these stocks could retreat.
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“That does create a risk obviously if the tax reform plan doesn’t come to fruition, or takes a lot longer to unfold,” he says. “(If) there starts to be misgiving of the pace of growth in the U.S. in future quarters, then it stands to reason these homebuilding stocks would be caught up in the trade of disappointment as it relates to the tax reform plan.”
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Can the Housing Sector Continue to Perform? originally appeared on usnews.com
