This is a different sort of blog, as I will be asking John Calverley, our Chief Economist, a few questions about US homebuilders and the housing cycle. For those of you who are not familiar with John, he is our housing cycle and bubble expert, having written a few excellent books about the subject.
Q1: John, you have been talking about a potential cyclical house price peak looming, how close is this now?
A: In June 2022 we published a Focus paper on housing, arguing that house prices move in a 16-18 year cycle and so, with the last US peak in 2006 we should expect another peak soon (by 2024). A rapid run-up in prices in the last couple of years of the cycle is typical, and we saw that in 2020-21.
I expected that the combination of higher interest rates and a recession would be the trigger and suggested that the downside potential for US house prices was 15-25% (similar for Canada, Australia and Germany with 10-15% for the UK). The declines would be bigger, except that rapid wage growth provides a cushion.
Well, so far, we have seen only modest dips in prices in the US – about 5% between June 2022 and last spring – and prices have risen again in recent months. Other countries have seen slightly larger declines, though it is early days. House prices have held up because there are very few existing homes for sale, while the demand from young home-buyers is still there. People are not selling because they would have to relinquish very cheap mortgages and, with unemployment still very low, there are few forced sales. Meanwhile, although US 30-year mortgage rates of 7.2% are at their highest level for over 20 years, young households are going ahead with purchases, perhaps hoping to refinance if rates come down. This has created a good selling environment for house-builders since they have limited competition from existing home sales.
Q2: At our last investment committee meeting you kept the chance of the US falling into recession in 2024 at 60%, how could this affect the housing market, both existing home sales and new home sales?
A: We have been expecting a recession for some time but, so far, the accumulated savings of US households from the Pandemic have kept spending going. A recession would change the outlook for housing, especially if interest rates stayed high for a while because the Fed wanted to make sure of defeating inflation. Forced sales would increase while some potential purchasers would hold fire. Recessions usually see low volumes of home sales, both existing and new, but the point is that sellers outnumber buyers so prices fall.
Q3: Below are some charts of the housebuilders that Buffet recent loaded up on, and an ETF that tracks the sector. My chart thoughts are below, but do you think Buffett is onto a winner here or will he need to wait some time to see some real returns?
A: Well, Buffet usually takes a long-term view of investments so I am sure he has calculated that the valuations are low enough to make reasonable entry points for a buy-and-hold strategy. That said, if we do see a recession, the chances are that there will be lower entry points next year. But the big home-builders have reportedly reduced leverage and are likely resilient to a recession. They might even benefit in the longer term if smaller builders are wiped out. Moreover, right now, housing starts are running at about 1.5 mn annually, which is likely below long-term demand. So there is room for growth.
Chart thoughts (from Gerry)
The charts are of DR Horton (top), Lennar (2nd from top), NVR (3rd) and ITB, the iShares US Home Construction ETF (bottom). They all have a ‘samey’ look to them as the share prices worked to new highs over the summer and are now consolidating. Technically, the drift below the 13-week moving averages and the drop in the RSI from overbought levels suggests that some consolidation to lower levels may extend. The 50-week moving average in the shares and ETF is a key level to watch on the pullback, ahead of rising line support. Ideally, for Buffett and other fans of the sector, the 13-week moving average won’t be lost for long and the 50-week moving average won’t be tested. New highs? Goldilocks will need to really work her magic on the US economy to fend off the bears.
The big risk is that there is a top in place for a break of rising line support and then a push below the 2022 lows may follow. Interesting times!