My head isn't turning away from the housing market

Güten Morgen, hello, hi.

Seriously can't shake the feeling that the housing market is the micro root of all evil (or at least where the largest risks are).

I've got a few charts and images I want to show you...

Let's start with this one.

Here's the Case Shiller House Price Index YoY vs average US mortgage rates.

What's interesting here is that as they have risen recently, we have seen a breakdown in the trend established through the COVID years; a slight dip in house prices has formed...

Obviously nothing substantial just yet, but there's certainly an impactful variable to note.

And it's obvious, right?

Mortgage rates higher means a certain section of mortgage holders are going to be affected - not those on a fixed rate, but those who perhaps didn't think mortgage rates would increase any time soon.

What you might also like to look at is this diagram...

Here's the original Tweet...

Now we might already have seen this play out in China, or at least be in the midst of it playing out, as unemployment has ticked up a bit.

In a US context, we can perhaps look at the Homebuilders ETF (XHB) for some colour...

Not looking too pretty, is it?

Now let's overlay that Case Shiller YoY Home Price Index too...

What's key to remember is that builders build when price is increasing.

What we might be seeing is a deterioration in price now, since the more responsive variable, XHB, is heavily in decline relative to the less responsive house price data.

You could argue that it's a similar mechanism to Dow Theory...

Essentially, if developers don't believe that price will increase, then why will they build?

And take into account rising materials costs...

This article from the UK states...

Take a look at the data here from the UK government (we can extrapolate this out globally since these components will be sourced from raw commodities, a global market) on price indices of building components for new housing (click table 1)...

December's price index was 139.2...

The annual average for 2021 was 128, and for 2020, the annual average was 112.7!

Basically, this is showing that the cost of building a home is extortionate.

So do we think that a tightening cycle is going to benefit the price of property, making builders more likely to build?

I don't.

And in Jan, we saw a decline in New Housing Starts in the US...

This confirms the view above, since one of the key reasons given was due to high materials costs, so we're starting to see a smaller margin on house price vs cost, which tends to come about amidst periods of uncertainty - the driving force of this uncertainty naturally being the tightening cycle and inflation.

If we include consumer sentiment in here too, can we make a case that the wealth effect is a seriously powerful factor on house prices?

Again, I think yes.

If people think their wealth is going to be eroded (either by rate hikes or by the inflation we are seeing today - they go hand in hand) then they're evidently going to have a shitty view on the economy.

What is interesting though is the potential lag here...

Consumer sentiment has cratered whilst house prices have rabidly increased since late 2020...

Seems to me like it's a bit of a tail wags the dog situation, which is all of macro to be fair, it's just about working out if there's opportunity within a certain window.

I wrote a thread the other day where the developer side was mentioned.

Here's the specific Tweet, but well worth reading the whole thread...

So what we are faced with here as well is essentially developers being stuck with excess leverage, even if their balance sheets had become more solid through the last few years.

And this is in similar vein to the Chinese developers.

OK, we haven't faced as ridiculous a gorge on land development, but surely there's the potential for interest rate sensitivities to have an effect on debt?

Take a peek at this chart.

We can see the dispersion here of different housebuilders and how close they are to negative events occurring (most probably due to rate rises).

This is less about the actual firms involved, but more to view these mechanism as a gateway into thinking how some housebuilders might be affected by a tightening cycle.

We can see that Empire Communities at the end of the diagram are pretty highly levered and were close to the 'negative sensitivities' level - they were already rated B- at the time of writing in August last year (full article can be read here).

I do not have the capacity to have a look at individual housebuilders and what their debt:cap. is, but what is probably relevant is if they have built and homes run empty as a function of flattened and decreasing demand, that debt:equity number will increase as housebuilders are sold off - which could be a bit of a doom loop til demand steps back in.

Keep an eye on the housebuilders, because as I mentioned above, it's likely these guys are the most sensitive to the macro climate, and so should provide a half decent indicator going forward.