Are Slowing Housing Starts Inflationary?

July’s housing starts were short of expectations, thus suggesting housing would add little to economic growth. The data suggests that July’s level was about half of the rate registered in early 2006. The reason for the short fall is not because of lack of demand, but from lot and labor shortages. Demand is there, but the product is not.

It is often written that real estate is all about location. Perhaps this is one axiom that I do agree with, for housing stocks are great in Detroit and Cleveland, but not in Westchester or Glen Allen.

Since 2009, demand for housing has outstripped supply. Approximately 1.4 million to 1.5 million housing units are required to meet demand. According to the 2015 census, housing demand was about 1 million units and housing supplies contracted by 418,000, thus suggesting “innate demand” is around 1.4 million units.

According to Bloomberg, since 2011, housing starts have averaged 994,000, thus suggesting a shortage of about 2.4 million units.

The lack of affordable housing in “desirable” locations is becoming a political issue where some are demanding legislative action. Additionally, home ownership is around 50 year lows. Ten years ago, home ownership was at a record.

I will not juncture into the politics of housing, but will write a major reason for the housing shortage is the result of Dodd Frank that has crushed the community banking industry that was responsible for lending to the smaller home builders that supplied about 30 to 35% of the nation’s housing stock.

I will comment, however, about the possible inflationary and monetary implications of a reduction in housing inventories. Owners’ equivalent rent (OER), or what someone thinks they can rent their home for, is about 30-32% of inflationary indices.

OER and rental rates historically track each other. Rental rates have increased near double digits for the last 6-7 years, but OER is essentially flat after falling dramatically in 2008-10. A major reason why “inflationary expectations” have remained benign is because of OER.

I rhetorically ask what happens if OER suddenly accelerates? How will such impact monetary policy, an environment perhaps amplified as the Fed begins to unwind its massive balance sheet?

It is now common knowledge that the vast majority of bulge bracket firms are forecasting a decline for the popular averages, partially the result of rising interest rates. As noted many times, interest rates are the largest component of valuation formulas.

On the opposite side of the equation, housing values are a primary variable in projecting retail sales and to overall consumer confidence. I rhetorically ask is the rise in home values a reason for the strongest retail sales in five months and robust confidence levels? Will such cause an increase in growth assumptions? If history is a guise, the answer is yes.

Changing topics, but perhaps analogous, oil inventories fell again this week, plunging by 8.94 million barrels versus the expected decline of 3 million barrels. This was the second largest drop since 2013 and inventories are now at the lowest levels since January 2016. According to Halliburton, infrastructure spending has plunged a record $2 trillion in three years, spending required to ensure future oil production.

Several major oil companies are warning of a possible supply shock in 12-24 months because of the lack of upstream investment. Shale is significant, but does little to combat the decline of mature wells that supply about 40% of the world’s crude supplies. Generally speaking, these mature fields are declining at an 8% rate as compared to the historical average of about 4%.

Oil declined about 1.5% on fears that greater US production will outweigh shrinking supplies. To write the obvious, there is a contradiction between what the market thinks and what the oil producers believe.

There were mixed reactions to the ending of several presidential business councils, an ending that again questions the viability of the Trump economic agenda. Reactions were also mixed to the Minutes from the July FOMC meeting.

Last night the foreign markets were down. London was down 0.40%, Paris was down 0.23% and Frankfurt was down 0.23%. China was up 0.68%, Japan was down 01.4% and Han Sang was down 0.24%.