A core element of Pinebrook’s macro framework is that the housing market is a core driver of the business cycle, and that the ebbs and flows of the housing market have high signal value in formulating the growth and inflation matrix and the general direction of the business cycle.
This has empirical backing, as 7 out of the 11 post war recessions have originated in the housing market.
That the current sectoral recession of the housing market has not thrown the broader economy into recession is nothing short of an economic miracle that has led to many false calls about a recession in waiting in 2023 or 2024.
Pinebrook’s view has been that the driver of the recessionary impulse originates in construction employment and unit construction and therefore avoided making a housing market driven recession call. Thus, the collapse in housing sales in this cycle, driven by historically high interest rates, was an economic fade.
By way of background, the U.S. housing market is about 15% - 18% of GDP dollars. This can be broken up in two ways.
Fixed Residential Investment (“FRI”) is around 3%-5% per year. This includes construction of new single and multi-family homes, prefabricated homes, and remodeling.
Housing services makes up the overwhelming majority of housing GDP weight, accounting for around 12% - 13% of GDP. This includes rents and utilities, along with owners imputed rent (an estimate of how much it would cost to rent an owner-occupied unit).
GDP tables (Table 1.1.2) published by the Bureau of Economic Analysis (BEA) on a quarterly basis going back to their inception in 1947 reveal that FRI contributes, on average, just 11-baisis points to U.S. GDP growth per year. This is literally a rounding error.
Table 1.1.1 reveals that FRI consistently registered the biggest (or second biggest) quarter to quarter changes to growth 6 quarters going into a recession and 6 quarters after a recession.
No other sector of the economy comes close in terms of its quarter-to-quarter volatility.
Obviously, every cycle is different. But there is a more than remarkable sensitivity between economic growth and housing going into a recession and coming out of one. Now in terms of the why, we are left wondering.
Why does a trivially small part of the economy with even more trivial contribution to overall economic growth seem to be the butterfly whose wing snap causes an economic hurricane?
Housing a volume story, not a price story.
Home prices are sticky on the way down.
Therefore, when there is a demand drop off, the initial adjustment mechanism is volume, not price.
Prices eventually follow, but with a lag.
The decline in volume means a decline in construction, manufactured durable goods, and every single other input that comes with the development of a new home.
From the architect to the banker, to the builder, vendors, designers, brokers, and on and on. A price decline is a haircut to the seller, and no one cares. A volume adjustment grinds a long chain of real economic activity to a halt.
This halt in real economic activity hits GDP accounting particularly hard. A seller taking a haircut on their home sale does not affect the “P” in GDP accounting. But historically, the associated fall in production that comes with decreased home building volumes does impact the P in GDP. Big time.
Simplistically, one can argue that the housing market indicator was shot in the head by the pandemic distortions to the economy and that it is now dead, like it’s yield curve cousin.
Perhaps, like the yield curve, it never worked in the first place and was a coincidence that kept happening again and again until it was assigned normative meaning.
This would be a false equivalence. Despite the largest increase in mortgage rates in two generations, unit construction and construction employment have remained high.
Compositional shifts from single family to multi-family construction are now around 60% versus 25% in the 1990’s. MFR take longer to build than SFR.
The backlog for MFR construction is now at 30-months.
The pandemic supply chain distortions kept projects alive longer than normal.
The market for SFR is structurally underbuilt.
The above is likely why we have the following chart, showing construction employment at post GFC highs and not rolling over and taking down the broader economy with it.
Everyone knows that everyone knows (a word play on Keynes’ famous beauty contest analogy) housing is a core cyclical driver. Less appreciated are the nuanced causal factors that caused many commentators to get the recession call wrong in this cycle.
A similar phenom is occurring with respect to the tech/AI boom. That is, everyone knows that everyone knows that FAANG/Mag7 names have been powering the earnings growth of the S&P500 for over a decade.
Flying under the radar is the idea that, despite being less than 10% of the U.S. economy, tech alone represents almost half of the market cap of the S&P500, and just seven big tech names are around a third of the same index.
Like housing, tech is now a macro-factor butterfly whose wing flaps will have an outsized impact on the broader economy.
The Mag7 will collectively deploy around a half trillion dollars in capex and fixed investment this year.