Perspective on Risk - June 2, 2022
Inflation, Disinflation, Deflation; Inflation and Real Estate; Inflation and Market Valuation
Inflation, Disinflation, Deflation
Market is pricing in a return on inflation to the 2.5-3.0% range
5 year breakeven 2.87%, down from 3.59%
5y5y breakeven 2.23%, down from 2.67%
Remember our thesis, the inflation we’ve experienced had three distinct drivers:
Stimulus-induced goods demand interacting with covid-related production and supply chain delays
Russia/Ukraine-related commodity price inflation (energy, fertilizer, foodstuffs)
Tight US labor market conditions and supply/demand imbalance
Stimulus induced demand has receded.
Used car prices, which were the early harbinger of this spike in inflation, are now falling.
Supply chain delays are easing; the port backlog is pretty much over
Commodity inflation MAY be peaking
And the labor market, despite still being tight, may also be rolling over. @PatheonMacro shares that Average Hourly Earnings will be pulling the core inflation rate lower.
So, core PCE may have peaked, not that you would know from the chattering class.
Inflation and Real Estate
The Fed tightening cycle probably doesn’t end until the overheating in the real estate market passes. There are already signs.
@AltosResearch calls an end to the “pandemic real estate frenzy.” Click through the below Twitter link for the full stream.
Summarizing:
The pandemic real estate frenzy is over.
Price reductions jumping. YoY inventory increases. Prices at record high.
Available inventory is up by 5.7% this week to 364,000 single family homes.
Immediate sales has been the defining phenomenon of The Frenzy. So, fewer immediate sales is an early indicator of The Frenzy ending. 6 weeks in a row we've had fewer percent of listings as immediate sales. Down to 23% from 33%.
Prices holding up stronger than expected
Tracking price reductions: Up to 23.1% of the market with price cuts. We'll be at a normal market by August.
We should note that inventory is still very low, it’s just that demand has fallen considerably as mortgage rates have risen. As McBride highlights on his substack: Worst Housing Affordability" since 1991 excluding Bubble
McBride notes the extent of the runup:
In nominal terms, the Case-Shiller National index (SA) and the Case-Shiller Composite 20 index (SA) are both at new all times highs (above the bubble peak). The National Index is 60% above the bubble peak, and the Composite 20 index is 48% above the bubble peak.
In real terms, house prices are now above the previous peak levels. There is an upward slope to real house prices, and it has been 16 years since the previous peak, but real prices appear historically high (Of course interest rates had been very low).
On a price-to-rent basis, the Case-Shiller National index is at a record high, and the Composite 20 index is back to November 2005 levels. … The price-to-rent ratio had been moving more sideways but picked up significantly recently.
McBride’s opinion is that the “housing boom and the unprecedentedly rapid home price gains” were a result of Fed policy.1
Interesting confirming anecdote from MSNBC: The Hamptons summer rental market is facing an unexpected chill as inventory piles up and prices come down
How will the slowdown play out?
Based on the fundamental underpinnings of today’s housing market, a market crash similar to the 2008 bubble bursting is highly unlikely, says Bill McBride, real estate analyst and author of the CalculatedRisk Newsletter.
Instead, McBride believes it is much more likely that our present housing market will behave in a similar fashion to the 1979-1982 market, which basically saw a market cooldown without a crash in home prices or a large number of foreclosures.
Some other observations:
Eric Basmajian points out that:
The single-family home sector deleveraged after the 2008 downturn
This time, the buildup in debt is more heavily concentrated in the multi-family sector, where debt to GDP is almost 8% compared to 6% during the GFC.2
Nick Timiraos shows how the multi-year decline in the inventory of existing homes for sale has not been offset by sufficiently increasing housing starts, contributing to tight supply conditions.
Joey Politano has a nice piece America's Homebuilding Boom (That Isn't). He notes:
However, the construction surge has still left total homebuilding at historically weak levels. Relative to America’s still-growing population, homebuilding is hovering near pre-2008 lows. That’s despite a deficit of millions of units that need to be built and a housing stock that is increasingly outdated.
Growth in the housing stock—which takes into account both new construction and new destruction—has also been extremely low compared to the pre-Great Recession years.
He also suggests that supply-chain issues may have increased construction time and decreased completions relative to starts:
Supply chain issues ranging from commodity prices to labor shortages have also put a damper on housing production. Housing starts have jumped up over the last two years amidst strong demand and rising home prices—but completions have not kept up. Projects are taking longer to complete thanks to rolling shortages and production interruptions that have plagued the industry.
As a result, the number of housing units under construction has surged to record levels and shows little signs of slowing.
At the same time, the number of housing unit authorized but not started is also at a record high. The same supply issues that is are delaying construction are also making it difficult to even break ground.
Finally, Nick Timiraos also shows that residential investment as a share of GDP is not very inflated. It seems clear that we need to increase housing supply, rather than just using rates to cut demand.
Inflation and Market Valuation
Historically, if inflation stays at current levels, the US equity market is vastly over-priced. Conversely, the current level of the market is more consistent with sub-2% inflation.
CalculatedRisk Newsletter, Lawler: Mortgage/Treasury Spreads Part II: “Decomposing” the Widening This Year
EPB Macro Research, [Chart Of Interest]: Single-Family Or Multi-Family?