Housing sector may be the skunk at the economic picnic

Second-quarter GDP is widely expected to show the fastest pace of activity in more than three years.

While there are a number of factors suggesting the economy is on solid footing, weakness in the housing market in particular calls into question the sustainability of above-trend, top-line growth in the second half of the year.

{mosads}Housing, after all, helps drive other sectors of the economy, including consumer confidence and spending, as well as construction and lending activity. While housing is no longer the large net drag on the economy it once was in the aftermath of the Great Recession, it is also no longer the driver of the economy it once was prior to the financial crisis. 

Housing slump

The latest data shows housing activity has continued to slump throughout the first half of the year, raising a red flag for the future of the broader recovery. Housing is considered a leading gage of overall economic health.

Accounting for roughly 15 percent of the economy, housing furthermore serves to drive consumer sentiment and various aspects of residential investment, including new construction and lending. As history has shown, when housing activity dries up, it’s usually a good indication the economic expansion will face additional headwinds as well, and sooner than later. 

In June, existing home sales fell 0.6 percent, dropping from 5.41 million homes to a 5.38-million annual pace. Year over year, home sales declined 2.2 percent at the end of Q2, the fifth month of decline on an annual basis in the past six.

Coupled with a slowdown in demand, construction activity has additionally weakened as of late. Building permits fell 2.2 percent in June from 1.301 million to a 1.273-million-unit annual pace, a nine-month low.

Over the past 12 months, permits declined 3 percent, the first annual decline since September 2017. June housing starts meanwhile fell 12.3 percent, the largest monthly decline in nearly two years and dropped 4.2 percent over the past 12 months.

Coupled with a loss of top-line momentum in sales, further monthly volatility and weakness in building activity has exacerbated fears of a worrisome, downward trend in housing.

New home construction, after all, is a key driver of construction-related employment, which has been a consistent contributor to monthly employment gains. Since January, construction employment has added 150,000 new payrolls. 

Expensive real estate

While housing sales have slowed, the run-up in housing prices has not, at least not yet, with inventories still near multi-year lows. According to National Association of Realtors (NAR), the median price for an existing home rose 5.2 percent in June from a year earlier to an all-time high of $276,900. 

A lack of inventory coupled with a solid demand for housing has fueled years of strong price gains. According to the NAR, the months’ supply of available homes for sale has broadly continued to dwindle from a peak of nearly 12 months to 4.3 as of June, only moderately above the all-time low of 3.2 in December last year.

At the same time, inventories have continued to dwindle, mortgage rates have moved higher, albeit modestly. Rising mortgage rates typically restrain housing prices, but the modest increase in financing costs thus far has been more than offset by reduced supply-supporting elevated prices. 

According to Freddy Mac, since the start of the year, the average interest rate on a 30-year, fixed-rate mortgage rose nearly 50 basis points to around 4.5 percent in June, still-historically low.

Affording a home

Arguably one of the most interest-rate sensitive sectors, rising mortgage rates coupled with still-moderate wage gains will decrease buyer affordability, further depressing home sales and undermining support for housing values. In other words, home prices are still on the rise, but home sales have started to soften.

With the cost of financing increasing, coupled with stagnant wages, the average American will find it increasingly difficult to afford a home purchase. Thus, a slowdown in sales, if sustained, will erode support for higher home values. 

At this point, consumers are already struggling to afford a home in the absence of meaningful wage gains.  Average earnings growth has trended just 2.1 percent since the end of the recession, pushing up to a pace nearer 2.5 percent more recently.

Despite improvement, however, wage growth is trailing appreciations in home values by more than a 2-to-1 ratio, a widening trend that is eerily reminiscent of conditions that went unchecked by market participants until it was too late during the housing bubble.

Without a meaningful gain in wages, a further rise in interest rates could serve to stagnate or eventually depress home values with an additional decline in sales activity.

It doesn’t appear as if the proverbial rug is entirely being pulled out from under the housing market. Although, the lack of activity during the key selling season, which market insiders designate as March to June, points to permanently lost ground. 

Conclusion

Despite what is being hailed as the strongest period of growth in years, a decline in activity in the housing market has indicated still-lingering headwinds for the recovery.

Increasingly long in the tooth, the domestic expansion appears still fragile with consumers on uneven financial footing, volatile business investment and clear signs of a reduced pace of housing activity, not to mention threats of a looming global trade war and rising fiscal deficits.

For the housing market, after a lengthy stretch of arguably unsubstantiated, yet impressive, price appreciation, the lack of corresponding improvement in wages coupled with rising interest rates could prove to be the needed — albeit unwelcome — conditions to reverse such a trend.

Amid a lack of meaningful wage gains, factor in rising mortgage rates and the ability for the average American to buy a home will be further restrained over the coming months. 

Lindsey Piegza is the chief economist for Stifel Fixed Income. Her research has been published in the Harvard Business Review and in textbooks for Northwestern University’s Kellogg Graduate School of Management. She’s a regular guest on CNBC, Bloomberg, Fox News and CNN.