“Dad, can we get a giant tent?”
- Jacoby Drake, age 8
My son served up that gem this past weekend while driving by a “Giant Tent Sale” sign outside of an electronics retailer.
The question was correctly placed. It’s one of those things that only makes sense in an isolated context and also presupposes prior knowledge.
Suppose, instead, the sign happened to say “Ford Explorer Sale” …. You’d be correct in expecting to show up and shop for a car, not with an expectation that someone would be hawking unrelated, random retail schwag … but from inside a Ford Explorer.
It’s also not immediately clear why I would want to buy something outside, after its been rummaged through, on a one hundred degree day for $16 when I didn’t want to buy it inside in the AC and unmolested for $20.
Macro dynamics have a sneaking tendency for being similarly paradoxical ….. your balance of payments and external position is deteriorating, fiscal deficits are set to rise significantly and there’s an deluge of supply in treasuries imminent (hint: 2Q18 dollar bear thesis) …
Giant Dollar & Treasury Sale, right?
Or, as we highlighted yesterday, take Soybeans.
Soybean futures are down -25% off recent highs amid trade policy angst and concerns around escalating protectionist policy crimping growth. But with soybean exports ramping +90% M/M and +105% Y/Y in May ahead of the tariff imposition, that prospective “growth crimping” will actually serve to juice GDP via improved net exports in 2Q18.
Growth down = growth up.
Remember, in Global Macro everything is obvious and nothing is what it seems.
Back to the Global Macro Grind…..
Anyway, everyone knows that chief among literary devices is an engaging hook that serves to capture the audience from the jump of the missive.
Everyone also knows that the most engaging intro’s involve esoteric trigonometric phenomenon.
Saturday’s may still be for the boys but Tuesday mornings are for generalized Damped Harmonic Oscillation modeling discussions.
I bring this up because @HedgeyeFIG and I will be hosting our 3Q18 Housing Themes Call tomorrow and part of the call will be devoted to detailing our evolving framework for contextualizing domestic housing data.
Damped Harmonic Oscillation, as it turns out, represents an almost perfect stylized model for describing housing fundamentals, housing related equity performance and the diminishing relevance of macro driven inflections in housing over the last 10 years.
I know it may sound sophisticated, abstruse and mathy but it’s not really that complex.
Harmonic motion/oscillation is really just another name for a periodic or sinusoidal type function and “damped” just describes the tendency towards the progressive decline in amplitude with each successive cycle over time.
The chart below is a visual representation. It’s basically just a wave that gets smaller with each successive cycle.
As it relates to housing - coming out of the GFC, housing fundamentals were cycling with significant amplitude. Price growth was ranging from +20% to -20% Y/Y, volume growth was cycling in the teens and regulatory risk lurked as an existential threat.
Housing was macro-centric, understanding prevailing top-down dynamics was essential and front-running macro driven inflections in housing fundamentals was alpha’s playground.
Conceptually, the modelling frameworks was both simple and empirically consistent across multiple cycles:
Housing Demand led Home Price Growth --> Home price growth followed the slope of demand on a 12-18mo lag --> housing related equities followed the slope of home price growth
In other words, if you knew what volume was doing (which we do) … then you knew what home prices would do a year from now …. And because housing related equity prices followed the slope in home price growth, you could make a high conviction forecast on housing exposure a year out.
There were always fringe dynamics and other externalities to consider but It really wasn’t more complicated than that.
However, as we’ve moved further out from the GFC and the housing market has slowly renormalized, the amplitude of successive price and volume cycles has progressively diminished and the framework described above began to breakdown alongside increasingly acute supply conditions in the existing market.
As volume growth mean-reverted back to average historical levels of activity and inventory became the principal gating factor on demand growth, the historical pattern of volume growth leading price growth broke down.
While we lost some medium-term predictive power, key elements of the model remain intact and, in conjunction with a fuller integration of our Macro GIP and Macro Housing models, forecasting remains a tractable exercise.
I won’t fully divulge the sauce ahead of the call tomorrow but since this is meant as a peak behind the process evolution curtain, here’s a selection of core elements:
- Supply still leads Price: The sequential change in months-supply remains a good predictor of 2nd derivative changes in home price growth
- Price Growth still correlates with Equity Performance: Housing related equity performance still tethers strongly to rate of change in HPI.
- Macro Overlay: The housing complex (where benchmark indices are generally builder-centric and/or broadly interest-rate sensitive cyclicals) shows consistent patterns of performance across varying growth and inflation regimes. For example, housing equities perform well during Quad 1 and Quad 4 environments.
The Chart(s) of the Day below illustrate the first two points above.
Now, consider the third point within the context of our expectation for a shift to Quad 4 into year end. Quad 4 is characterized by both growth and inflation slowing, macro dynamics associated with falling rates and an incrementally dovish policy stance. But there is a good chance that lower highs in rates and the slowdown in headline growth comes alongside progressive upside in domestic wage inflation.
In other words, we could see an investible period where falling rates support (housing) affordability while improved income growth continues to support underlying (housing) demand. Additionally, those dynamics would be emergent in the wake of significant underperformance for housing related equites and against a still favorable longer-term backdrop as the housing cycle itself remains only mid’ish-cycle given the lagged inflection in construction and transaction activity out of the GFC.
Giant House Sale?
Stay tuned.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND signals in brackets) are now:
SPX 2 (bullish)
NASDAQ 7 (bullish)
Industrials (XLI) 71.60-73.75 (bearish)
VIX 12.33-18.60 (neutral)
USD 93.50-95.32 (bullish)
Oil (WTI) 70.04-75.55 (bullish)
Gold 1 (bearish)
Copper 2.77—2.97 (bearish)
Christian B. Drake
U.S. Macro Analyst
