House of Blues?

Okay, 2 things:

1. Housing

2. Jobs  

You can’t get a house if you don’t have a job and (in the promised future state where everyone works remotely) you can’t do your job if you don’t have a house.  

And enigmatic chicken or egg macro paradoxes don’t analyze themselves, so pitter patter, let’s get ‘ater ….

 

Back to the Domestic Macro Grind…

We’ll see where things wash out but, on its face, the GOP tax Reform proposal released yesterday was almost universally negative for housing.

There were 3 primary provisions of relevance: 

1. Mortgage Interest Deductibility:  For new home purchases, interest would be deductible only on loans up to $500,000, down from $1 million today; existing loans would be grandfathered.
2. SALT & Property Taxes:  The GOP plan repeals the deduction for state and local income and sales taxes (SALT). It allows a deduction for property taxes, but caps it at $10,000. That limit applies to married filers and individuals.
3. Exclusion of sale provision  -->  To qualify for exclusion of capital gains on sale of a residence, the seller would now have to live in the property as a primary residence for 5 of the last 8 years (currently 2 of the last 5 years) and could only take that exemption every 5 years (currently every 2 years). 

 The implications are relatively straightforward:

1. The change in exclusion of sale provision would likely serve as an incremental drag on supply/turnover. 
2. The MID and SALT changes would pressure home values at the middle-to-upper-middle tier and drag on demand at the high end.
3. The grandfather clause in the MID provision – which maintains full mortgage interest deductibility on existing loans - would serve as incremental drag on new supply. 

And it shouldn’t be lost on anyone that these changes are now impending at a time of acute supply shortage and inventory led rollover in volume growth.     

The low-to-middle tier could be seen as a beneficiary under the proposal but that benefit is conditional and ceteris paribus.  Recall, the lower end is where supply pressures are most acute and a further shift in the demand-supply imbalance would largely manifest in price (i.e. lower affordability).   

Companies with outsized sensitivity to the high and ultra-high end of the housing market – such as real estate service company Realogy (RLGY) - are the most at risk. 

Indeed, we pulled RLGY off our Best Idea Long List in Housing immediately following release of the reform details.  Our bullish call on RLGY was predicated on a resurgence in the high end of the housing market. That resurgence has, in fact, been realized and is now largely rearview.

Progressively harder comps, prospects for a concomitant, tax-reform catalyzed reduction in supply and demand at the high end and a dearth in discrete positive catalysts in the medium-term changes isn’t the trinity that convicted bull theses are made of.

Should the GOP plan be watered down and greater accommodations made for high end homebuyers/homeowners, then it could once again become compelling.

Indeed, as David Hoppe, former chief of staff to Speaker of the House Paul Ryan, noted yesterday afternoon on our Tax Reform Flash Call, the MID provision is likely to be "the key issue" in the House markup in the coming week(s).  

Anyway, we’ve had a good run in the name and are comfortable with passively observing nearer-term developments.

Moving Along …

Here’s the context around this morning’s Employment report:

1. The September Employment report was steeped in Hurricanes related distortion which, primarily, manifest in the cratering of net employment gains and in the inflation of hourly earnings.
2. Specifically, net job gains in Florida tanked and the industry most affected by the storms – Leisure and Hospitality – lost -111K jobs.  Meanwhile, comparably well-paid Utility (and construction) workers worked a lot of overtime … pushing up average hourly earnings for the industry and helping to juice headline earnings growth. 
3. Consensus expects both of those distortions to resolve with a net gain of +313K on Headline NFP and a moderation in earnings growth down to +2.7% Y/Y (from +2.9% in Sept).    
4. Initial Jobless claims – after the Hurricane related spike in August - continued to plumb new 40 year lows in October.   Indeed, the 44 year low in Initial Claims reported during the Employment Survey week is a direct positive for net payroll gains.  Moreover, the rolling trend in Initial Claims has been one of the most consistent lead indicators for the labor market and broader macro cycle over the last 7 cycles.  Dislocations in the equity and credit markets don’t really propagate until job loss inflects and accelerates  - and, as it stands, Initial Claims continue to put in peak improvement.
5. The Conference Board Labor Market Differential Index, The Empire State and Philly Fed Employment Indices and the ADP Private Payroll report all advanced markedly in October.  The ISM Employment series dipped -0.50 pts in October but, at an index level of 59.8, remains at 5-year highs and well in expansionary territory. 
6. The ECI (employment cost index) for 3Q released on Tuesday continued to accelerate.  Indeed, growth in Wage and Salary costs accelerated to a new 10Y high at +2.5% Y/Y in 3Q17.   Still underwhelming? Yes.  But the trend is irrefutably accelerating as the expansion continues to mature and the labor markets plods towards increasingly tautness.

The saying goes that the sell-side gets paid for being loud, not being right.  Maybe, maybe not. 

The simple reality this month is that consensus is probably ballpark correct in terms of expectations and there’s not really a high probability, sensational call to make on the NFP data.  

Underlying fundamental trends in massive DM economies don’t just whimsically step function around to indulge our increasingly vacuous lust for serial sensationalism. 

With growth, investment, profits and productivity still accelerating, the labor market will continue to tighten and Phillips Curve enthusiasts may continue to lay claim to a flatter but, still imperishable, macro reality. 

For the record, here’s the new Chairman-elect Powell’s official view on the relationship between inflation and labor tightness:   

“If you look at the relationship between slack in the economy and price inflation, and then you look at the relationship between price and wage inflation – both of those relationships have weakened very substantially over the last 20 years. To say it differently, wage inflation, which has been weak, no longer affects price inflation as much as it used to, and price inflation is no longer as responsive to the economy getting tight. So you can be at full employment and you don’t see much inflation. This is very different from the world we grew up in of wage-price spirals and such. So all of that I think is consistent with a world in which companies maybe substitute capital for labor and labor’s share of income goes down. It’s in the numbers but it’s not something I feel we can target directly with our policies.”

Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:

UST 10yr Yield 2.32-2.47% (bullish)
SPX 2 (bullish)
NASDAQ 6 (bullish)
Nikkei 215 (bullish)
DAX 13170-13535 (bullish)
VIX 9.36-11.62 (bearish)
USD 93.50-95.27 (bullish)
GBP/USD 1.30-1.32 (bullish)
Oil (WTI) 52.22-55.40 (bullish)
Gold 1 (bearish)

Have a great weekend,

Christian B. Drake
U.S. Macro analyst