HOusing affordability is awful
According to the St. Louis branch of the Federal Reserve, as of August 2023, the median household income is $70,784. Meanwhile the median home price is $416,000 (per the Federal Reserve). That means that the ratio of median home price to median income is nearly 6:1. In certain real estate “hot spots” like San Francisco and Los Angeles the ratio reaches as high as 13:1. After hovering in the 3:1 or 4:1 range for the 1980 and 1990s the ratio shot up during the housing boom of 2005 – 2007 before contracting again during the recession in 2008-2009. The home value / income ratio remained elevated for the better part of the last 15 years; brought on from low interest rates and a booming housing market. Many economists believed that house prices would moderate with rising rates, but home prices have stayed stubbornly high as supply has dwindled. Combine the elevated interest rates with a shortage of available housing and we can see why the Goldman Sachs housing affordability has never been lower going back to 1996. In fact, comparing the median home prices to median income levels suggests that there hasn’t been a worse time for home buyers in the last 40 years.
People AreN’T MOVING
As you’d expect based on the results of the chart above (housing affordability is awful), mortgage applications have fallen off a cliff. Homes are still selling relatively quickly when they hit the market, but there are so few homes changing hands that total applications are back to a quarter-century low point. As it turns out, very few homeowners are willing to walk away from a great mortgage rate in return for a new 7%+ rate. The lack of supply has kept home prices elevated.
What are homeowners waiting on?
What could grease the wheels of the real estate market? The expectation of lower interest rates. The current expectation is that is that interest rates will peak for this cycle in late 2023 / early 2024 before drifting lower. These cuts should (in theory) filter through to other parts of the economy and bring down mortgages rates in the process. While I highly doubt that we will see 3% mortgages again anytime soon, the general consensus is that rates are heading lower. If / when rates decline, we should begin to see supply come back on line and housing affordability should improve. The hope is that declining mortgage rates (whenever they occur) doesn’t lead to a flood of inventory from homeowners who felt “trapped” by the higher rates. If so, we may see home prices contract along with falling rates which could lead to the ultimate “buyer’s market”… but we are a long way from that storyline at the moment.
Rates Aren’t Having the Same Impact on Corporate America
Unlike prospective home buyers, corporations in general haven’t been nearly as hampered by the rising interest rates. This chart illustrates the point that nearly half of all outstanding debt for S&P500 companies matures after 2030. The consumer feels the impact of rising rates much more than corporate America. Of course, the consumer is the driver behind corporate profits… but it’s nice to know that corporations aren’t “doubly exposed” to rising rates.
Recession Watch
Other than increasing interest rates, the Federal Reserve is also shrinking the money supply for the first time in 60 years! Why would the Fed do this? In short, as the money supply decreases it makes lending more restrictive and thus acts as a headwind for economic expansion… which is a key ingredient to fighting inflation. The contraction of the money supply isn’t a total shock given how much the money supply expanded in 2020 – 2021 due to COVID. The pendulum tends to swing hard in both directions. I suspect that the money supply will stay tight for the near future until we see an economic slowdown. This doesn’t bode well for economic growth, but it may be less of a headwind than usual given the dramatic expansion of the money supply preceding this contraction.
Consumers are Feeling the Pinch
Are we seeing an economic slowdown yet? Perhaps. If you look closely, you can see some cracks in the foundation. Delinquencies for consumer, credit card and auto loans are all on the rise for the first time since the 2008-2009 financial crisis. This could signal a slowdown in future consumption as credit card balances recently topped $1 trillion nationwide, with an average interest rate of 24.37% according to LendingTree.com. This uptick in delinquencies is likely to continue so long as interest rates remain elevated and debt levels increase faster than household income levels.
Temporary Employees are on the Decline
The measure of “temporary employment services” may serve as a decent economic indicator. Small businesses are typically the main user of “temp services”. While overall employment numbers remain relatively strong, the recent decline in temporary hiring may indicate that ‘main street’ is tightening its belt; which could be a precursor to a slowdown of hiring in general. Ultimately, a tight labor market is one of the final signals that a recession is on the way. Temporary Employment hiring contracted before each of the previous three recessions. Will this time make it 4 for 4? We shall see.
What about stocks?
While cracks in the foundation may be forming, the market may continue to ignore the warning the signs in the near term. Economic data is released sparingly and trends take time to change. At the moment, “bad” economic data is viewed as a sign that the Fed may back-off restrictive policy rather than being seen as concern over an economic slowdown. The market is far more focused on surprisingly good corporate earnings and the growth of artificial intelligence. Until this narrative changes, I expect the stock market to hold up relatively well. As the chart above indicates, there are several instances in which the stock market entered September with double digits gains after a down month in August. In every instance, the market continued the rally through the rest of the year.
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