This article is from the Australian Property Journal archive
The US housing boom is now ending, leading some to worry about a sharp downturn in US and global growth.
During periods of weak share markets it often seems like all the news is bad. The last two weeks has seen this with concerns about inflation, interest rates, growth, China, oil prices, high bond yields and even bird flu. A US housing downturn is a potential addition to the worry list.
The booming US housing market has been a significant driver of US growth in recent years. The main impact on the economy has come via rising house prices fuelling a debt financed increase in consumer spending (via so called “home equity withdrawal”). Many worry that as the US housing cycle turns down, it will be bad news for US consumer spending and that this will spell doom for global economic growth, which in turn will drag share markets down even lower over the year ahead.
The US housing cycle has rolled over
A US housing downturn is evident in a range of indicators:
· housing affordability has plunged to early 1990s levels in response to the surge in house prices;
· the proportion of consumers who see now as a good time to buy a house has collapsed;
· new mortgages are down 15% year on year;
· new home sales are down 6% year on year;
· the inventory of unsold homes has risen sharply;
· annual growth in existing house prices has slowed to around 5% from 15% six months ago;
· housing starts are 11% below year ago levels; and
· the National Association of Home Builders (NAHB) housing index (ie, a survey of home builders regarding current and expected conditions) has fallen sharply.
House prices and consumer spending
A US housing downturn will result in a slowdown in US consumer spending, which accounts for 70% of US GDP. This is largely because consumers will no longer be able to rely on rising housing wealth to underpin higher debt levels and hence strong growth in consumption. The relationship between the housing market and consumer spending is shown below, with the recent decline in the home builders’ index pointing to weaker consumer spending ahead.
Source: Thomson Financial, AMP Capital Investors
But before considering how deep the downturn will be, it is worth putting the US housing boom in context and looking at the UK and Australian post housing boom experiences.
The US housing boom has been relatively mild
US house prices have certainly risen sharply, with average house prices up 8% pa over the last five years. However, the US house price boom has been mild compared to those in the UK and Australia which preceded it by two years. Over the five years to 2003, UK house prices rose 13% pa and Australian house prices rose 14% pa.
Source: Thomson Financial, AMP Capital Investors
As a consequence, while the ratio of house prices relative to wages has increased in the US, it is still less than is the case in Australia (see the next chart). In the US it takes 400 weeks of average wages to buy an average house compared to 500 weeks in Australia (ignoring tax).
Source: Thomson Financial, AMP Capital Investors
So with the US housing boom being relatively mild the risk of subsequent macro economic instability is arguably less.
The UK & Australian post housing boom experience
UK and Australian house prices rose sharply until around late 2003/early 2004. This saw house prices rise rapidly relative to rents and wages and was met by rising interest rates. The last couple of years have seen in both countries:
· average house price gains soften or flatten out;
· a slowdown in consumer spending;
· a moderation, but not a collapse, in economic growth;
· reduced pressure on interest rates, in fact UK interest rates have fallen; and
· relatively strong share markets (including in industrial shares in the case of Australia).
The key point was that a much feared crash in house prices, dragging down consumer spending and economic activity and housing and consumer related shares did not eventuate. While the resources boom helped offset housing related softness in Australia, this was less of an issue in states like Victoria and NSW (where house prices have still not collapsed) and has certainly been less of an issue in the UK. The main factor contributing to a soft landing has been the absence of a sharp rise in interest rates or unemployment causing debt servicing problems and forced selling by home owners.
Expect a soft landing in the US
Drawing in part on the UK and Australian experience there is good reason to expect the US will have a soft landing:
· First, the UK and Australian experience suggest that in the absence of sharply higher interest rates or unemployment there is no reason to expect house prices to collapse. With underlying inflation remaining relatively constrained and increasing evidence the US economy is slowing, aggressively higher interest rates are unlikely. We expect the Fed to soon go on hold, probably leaving rates flat at its late June meeting.
· Thirdly, around 80% of US mortgages are fixed rate loans meaning that borrowers are mostly protected from higher interest rates thereby helping to avoid debt servicing problems and forced sales. This contrasts with the situation in Australia, where 80% or so of mortgages are variable rate, and in the UK.
· Finally, the US housing boom has been milder than in the UK or Australia suggesting less risk of a collapse.
Our assessment is that the US housing downturn will see US growth slow but not collapse. We are looking for a mid-cycle slowdown much as occurred in 1986 or 1995 where US growth slowed to around 2.5% providing a positive environment for financial assets.
Is a US housing downturn good or bad for shares?
Many worry that a US housing market slump will be bad news for the US share market. Certainly there is reason to be concerned. Slower consumer spending and housing construction activity may be bad news for retail, building material and homebuilder shares and slower credit growth may be bad news for banks. If inflationary indicators remain high for a while, as is often the case because inflation lags the economic cycle, and housing continues to slow, talk of stagflation will start to do the rounds as it seems to with rather boring regularity.[1] However, a weakening housing market has a number of positives for the share market:
· Weaker housing and consumer spending will take pressure off US interest rates, although this doesn’t rule out a period of short term nervousness as investors fret about stagflation or a hard landing; and
· Investors will likely switch from housing to other assets, possibly shares, on perceptions that housing has had its day and that the fall in residential rental yields makes housing a less attractive investment.
The ending of the housing bubble in the UK and Australia has been positive for shares. As house prices have slowed or stagnated over the last 2 years, share prices (and not just resources stocks) in both countries have moved significantly higher. By contrast US shares are up only marginally over the last two years thanks to the Fed having “its foot on the brake”.
Which way it goes in the US will depend on how the housing boom ends. We expect US house prices will simply stagnate, as opposed to collapse.
Conclusion
A US housing downturn is likely to lead to a slowdown in US consumer spending and economic growth over the year ahead. However, the UK and Australian experiences post their housing bubbles suggest that US house prices are unlikely to collapse, US economic growth will slow but will still remain reasonable and that the ending of the US house price bubble will ultimately be positive for shares as it takes pressure off US interest rates. A soft landing in US growth should in turn be positive for global growth and share markets and help ensure the current weakness in metal prices and resources stocks is short lived.
By Dr Shane Oliver, chief economist and head of investment strategy with AMP Capital Investors.*
[1] Stagflation described the chronic economic stagnation & very high inflation (10% or so) of the 1970s. It should not be used to describe the normal very short term cyclical phenomenon where growth slows before inflation does.
