The Bigger They Are...

“The bigger they are, the harder they fall”

Wall Street missives employ all manner of idioms and loose analogies in an attempt to contextualize prevailing conditions.  

In fact, creative or entertaining abstractions have evolved to be a compulsory and distinguishing feature of published research that runs parallel to - and sometimes in place of - the core objective of actually generating research alpha.   

To be sure, it’s not that the world ever really needs another manufactured analogy lobbed into the investment metaphor (and metaphorical) ether …. but to the extent it helps investors internalize prevailing conditions and provides an analytical basis by which one can assess whether extant dynamics are likely to persist or marginal changes are evolving in such a way as to drive a shift to a new equilibrium and market narrative, they remain a useful construct.  

But that’s coming from someone who explicitly traffics in data curation and creative analytical contextualization … so, you know, grains of salt and what not.  

And besides – and just to grab an example from yesterday - with the likes of Italy posturing to effectively disregard EU budget guidelines while simultaneously asking that same EU for an Italy specific QE program to buffer the (probable) bond market effects of that same protectionist push into fiscal profligacy, “creativity” and “entertaining” are now simply a market feature, not a defining personal attribute of an analyst.

Back to the Global Macro Grind… 

The PCE (PCE = Personal Consumption Expenditures … which, for our new non-institutional readers, is just the technical, not particularly intuitive name for total household spending) data for July headlines the domestic macro calendar this morning and it matters again in terms of mapping the combined effects of unprecedented late-cycle fiscal stimulus and late-cycle percolation in wage inflation on collective domestic consumerism … which remains part and parcel of our #GrowthDivergences theme and a discrete input in the Fed’s Monetary Policy calculus … which feeds into the Policy Divergence theme … which remains a fulcrum factor for the dollar … which remains a fulcrum factor in the outlook for EM assets, etc, etc.

Recall, also, the benchmark revision to the NIPA accounts in July saw a significant upward revision to the personal savings rate, a change that effectively reversed the existing savings rate-consumption dynamics and baseline outlook. 

Specifically, whereas the savings rate was set to become a headwind to reported consumption growth prior to the revision, it now has significant room to decline in the service of supporting consumption growth should accelerating wage inflation be slow to manifest (for more, see: Early Look: Macro Hacks).

Elsewhere, outside of the upside surprise in Consumer Confidence (see: Here), most of the marginal macro developments of consequence this week were housing related. 

This is where I’d like to give some focused attention. 

HPI (home prices) releases over the last 18-months have largely been predictable, non-events as the combination of all-time tight inventory conditions and solid demand conspired to drive a steady acceleration in home price growth. 

The last couple months have been more interesting, however, as price growth across each of the primary HPI series have decelerated. 

There are competing explanations:

1. The HPI data is notoriously lagging.  For example, this week’s Case-Shiller HPI data was for June – and in addition to being released on a two month delay, the series is calculated as a 3-month rolling average (April-June).  In other words, it effectively gives you “insight” into prevailing price conditions in May.  The implication is that the modest deceleration observed in the more recent reported data could be associated with the backup in rates observed in Feb/March.  That is not unreasonable and we’ve seen similar Rate-HPI dynamics accompany prior rate shock periods. 
2. It could be that housing hotbed geoghraphies have begun to hit a critical threshold in affordability which – alongside a pullback in foreign demand – have served to quell further price acceleration.  
3. It could also be a compositional effect whereby heavyweight cities in the index are slowing and dragging the composite index lower despite continued strengthening in HPI trends more broadly.

This week’s Case-Shiller HPI data for June marked a 3^rd month of deceleration across both the 20-City and National Series and follows a 4^th month of slowdown in June’s FHFA HPI series reported last week.   

Of course, the trinity of considerations above aren’t (necessarily) mutually exclusive and while 2^nd derivative changes in home prices have, historically, followed changes in supply conditions on an approximate 2 quarter lag (the slope of HPI has been moving nearly concurrent with rising inventory in recent months), the current multi-month deceleration has been made more interesting in light of some other recent data/industry commentary. 

Consider the following from RDFN CEO on their 2Q call in which he describes a conspicuous slowdown in activity across some key geographies (emphasis added)…

Before turning the call over to Chris, let's address changes in the real estate market. Year-over-year U.S. home sales declined in June. We expect U.S. home sales growth to have improved slightly in July then to weaken again in August and September. What's striking about this change is that it seems to have been driven by diffident demand from homebuyers, not just the low supply of homes for sale. Nationwide, there were still 5% fewer homes for sale in July 2018 than in July 2017, but in Seattle, Portland and San Jose, where prices have increased the most, the percentage of homes selling in the first two weeks on the market declined in June from 61% to 52%, and the percentage of listings that dropped their prices increased from 31% to 33%. June sales were down in these markets by double-digits and inventory was up also by double-digits. The trend is continuing in July and reports are now coming in from Washington D.C., Boston, Virginia and parts of Chicago as well that homes there are getting harder to sell. As U.S. home prices have increased faster than wages for 70 straight months, buyers in markets like these have finally had enough at least for now. There is still plenty of markets where homebuyer demand is strong but for the first time in years we are getting reports from managers of some markets that homebuyer demand is waning, especially in some of Redfin's largest markets. In July, the percentage of U.S. homes that sold above their listed price declined year-over-year for the first time since March 2015.

Interesting color and, of course, a nice support to our Short RDFN call.

Second, the slowdown in Mortgage Purchase Applications has been accelerating. Purchase Application volume was down -80bps sequentially in July and is tracking down -7.2% sequentially in August.   Looking back, August has slowed in each of the last two years (-4% in each) but this year’s slowdown is more stark.

Third, the malaise blanketing transaction volume in the existing market is unlikely to lift any time soon. 

Pending Home Sales (PHS) for July fell -0.7% sequentially and -2.3% Y/Y, marking a 7th consecutive month of negative growth and continuing the 3Y trend toward deceleration.   Comps get marginally easier the next two months before stepping up considerably over Oct-Dec.  So while base effect dynamics may support some rate-of-change improvement the next two months, it will be mostly optics.

Net of all of that, there are a number of conclusions:

1. Critical Thresholds …. Critical thresholds are many times only apparent in the rearview.  To have hit a critical price-demand-affordability threshold in some of the hot local/regional markets wouldn’t be particularly surprising but it’s difficult to take a convicted view on a month of data.  That said, there were some compositional effects apparent in the Case-Shiller data with discrete decelerations in some heavy-weight markets disproportionately impacting the headline ….
2. The Bigger They Are …. For example, New York carries a 19.4% weighting in the index and registered one of the largest rate-of-change moves in the Index, decelerating -50bps sequentially on a Y/Y basis and slowing a full -200bps in the last 4 months.  Similarly, Los Angeles, which carries a 15.1% weighting, has slowed -60bps over the same period.   The 2^nd derivative trend in price growth across the 20-cities comprising the Case-Shiller index is plotted in the Chart of the Day below. 
3. HPI ↓ = Equity Performance ↓? ….. Historically, housing related equities tether to the second derivative trend in HPI.  A deceleration in price growth would be a headwind for equity performance – particularly if similar dynamics manifest in the New Home market where concerns around margin pressure (lot/labor/regulation/raw materials costs) are already an acute concern.
4. Medium and longer-term, rising supply (see: EHS | Adios, Albatross) and moderating price growth are a fundamental factor set supporting incremental gains in transaction volume and further renormalization in the housing market but …  
5. Near-term … the sequential decline in PHS, the fall in purchase application volume and the still notable positive spread between Existing Home Sales (closed transactions) and Pending Home Sales (Signed Contracts) all suggest the balance of risk for Existing Home Sales remains to the downside over the coming month(s). 

There’s more contextualization to be had as we continue to stalk some potential long housing exposure into year-end but the Bigger (longer) They Are, The Less They Get Read ….. in investment missive space, so we’ll cap it there this morning.

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

UST 10yr Yield 2.79-2.91% (bearish)
SPX 2 (bullish)
RUT 1 (bullish)
NASDAQ 7 (bullish)
Utilities (XLU) 53.01-54.77 (bullish)
REITS (VNQ) 82.56-84.75 (bullish)
Industrials (XLI) 74.90-78.05 (bearish) 
VIX 11.40-13.66 (bearish)
USD 94.20-96.55 (bullish)
EUR/USD 1.13-1.17 (bearish)
Oil (WTI) 64.13-69.99 (bearish)
Gold 1180-1226 (bearish)
Copper 2.58-2.76 (bearish)

Best of luck out there,

Christian B. Drake
U.S. Macro analyst