Data over the past month continues to confirm my fears that the US housing recovery is going into reverse. The argument was summed up yesterday by S&P’s chairman, when reporting Case/Shiller housing price data for December:
“The housing recovery is faltering. While prices and sales of existing homes are close to normal, construction and new home sales remain weak. Before the current business cycle, any time housing starts were at their current level of about one million at annual rates, the economy was in a recession”.
Last month should have been a good month for the housing market, as January 2014 was marked by some of the worst winter weather ever seen in the US. Yet existing home sales last month were up just 3.2% versus 2014, and even fell 4.9% versus December’s already weak figure.
A survey by the National Association of Realtors highlights one key reason, that homeowners now tend to stay 10 years in a home before moving, rather the 7 years that was common in the past. The problem is that prices are too expensive for younger people, and so the percentage of first time buyers is now down to 28%, compared to the 40%+ level common when the market was booming.
Another key element is in the chart above, which shows home ownership rates since 1980 from the US Census Bureau. It highlights how increased home ownership became a national policy under President Clinton. He consciously aimed to boost home ownership, as he set out in 1995 when launching the new policy:
“It seems to me that we have a serious, serious unmet obligation to try to reverse these trends (of lower home ownership). As Secretary Cisneros says, this drop in home ownership means 1.5 million families who would now be in their own homes if the 46 years of home ownership expansion had not been reversed in the 1980′s.
Now we have begun to expand it again. Since 1993, nearly 2.8 million new households have joined the ranks of America’s homeowners, nearly twice as many as in the previous 2 years. But we have to do a lot better. The goal of this strategy, to boost home ownership to 67.5 percent by the year 2000, would take us to an all-time high, helping as many as 8 million American families across that threshold”.
The policy was continued after Clinton, as subprime lending to lower income groups took a major role in the housing market. But the peak home ownership rate proved to be 69% in 2004-5. Since then it has been sliding steadily downwards, and was back at 1995′s rate of 64% in Q4 last year.
It seems safe to assume this decline will continue. As January’s housing start data confirmed, there is now a clear new trend, towards multi-family housing, which is now 36% of the total – double the percentage in 1995. The BabyBoomers are moving back to the cities as they retire, and the decline in fertility rates means younger people have less reason to need a family-size home in the suburbs.
Some of these trends were obscured during the energy bubble of the past few years. Hundreds of thousands moved to work in the oil and gas producing states, and naturally created major demand for new housing. But now even that support is being reversed as well, as I discussed last month, as oil prices return to historical levels.
We now have full US Census Bureau data for housing starts in 2014, which shows:
- Starts returned to the 1m level for the first time since 2007
- They were also nearly double the low of 554k seen in 2009
- But at 1.006m, they were less than half of the 2.068m peak in 2005
The data also confirms the dramatic swing away from single-family homes towards multi-family apartments. These were one-third of total starts in 2014, around double the average seen between 1989 – 2007, and back to levels last seen around 40 years ago – before the BabyBoomer home boom began.
The data is also a sign of the overall decline in home ownership levels, which at 64.4% are back to 1995 levels, when records first began. As with employment, there is also a major divide between ownership rates for the relatively wealthy White population at 72.6%, and those for the poorer Hispanic (45.6%) and Black populations (42.9).
Equally significant is the data for the major regions in the US since 2009, as the chart above shows:
- The largest gain has been in the South, which averaged 500k starts in 2014 versus 260k in 2009
- The West also saw a large percentage gain, with starts doubling to 235k in 2014 versus 115k in 2009
- Gains in the North East and Mid-West were more modest at 50k and 65k respectively
As the map from the US Energy Information Agency on the right shows, 3 of these regions have also seen strong growth in oil/shale gas-related activity.
It highlights the 7 most prolific areas, responsible for all domestic natural gas production growth, and 95% of all domestic oil production growth, between 2011-2013.
Clearly it would need more detailed study to directly link this data with growth in housing starts. But we do know that workers have flocked to these regions in search of jobs.
Separate Census data shows that Houston had the 2nd fastest growth in population in 2013 (after New York), and Texas had 3 of the top 10 cities in the list of fastest growing cities.
And according to the Census, Texas added more housing units than any other state as a result.
But now, the boom is turning to bust, and companies are laying off workers – particularly in labour-intensive areas such as drilling and support services. Major job losses are already underway at Schlumberger and other key employers.
We won’t know till March or April just how bad the hit will be to housing. But it seems more than likely it will end the recent recovery in housing starts, taking 2015 levels back below the 1m level again.
Conventional wisdom seemed to think the US housing report was positive this week. But analysis of the data makes it hard to see why.
One confusion comes from media use of the ‘seasonally adjusted’ number. But why do we need an adjustment, when we have data going back to 1959? It simply creates more potential for error. The chart on the left, for example, uses the raw data to give a 10-year view of the monthly pattern:
- Momentum has clearly been waning through 2014 (red line) versus 2013 (green)
- Starts are up 7% so far this year, after a 16% rise in 2013 and a 21% rise in 2012
- November’s decline suggests the market has already peaked, rather than being in recovery mode
A second confusion comes from focusing on just a monthly number, and not seeing the bigger picture.
The right-hand chart shows developments in home ownership since 1995, when records begin. It shows very clearly that ownership peaked at 69.2% in 2004. Q3 Census Bureau data shows it is now back at 1995 levels of 64.4%.
Neither chart therefore supports the idea that this week’s data was positive. Not does analysis of US home price developments, which shows prices have plateaued in recent months. The reason is that a strong market would need large numbers of young people to be buying first homes. But today:
- The relatively wealthy white BabyBoomers are now moving ever-closer to retirement
- The youngest is now 50 and the oldest is 68
- The key to future house sales lies with the younger demographics – who are mainly Black and Hispanic
- But they earn much less than whites on average, so their ability to afford today’s prices is much more limited
The problem, of course, is that financial markets don’t really care about this level of analysis. The average holding period for a stock is now only 3 – 4 months. So players are simply looking for a trading buzz – a quick headline to make the indices jump up or down.
This creates a very dangerous environment for companies and investors, as price discovery is not taking place in the market on the basis of real supply and demand fundamentals. Instead, it is being driven by random headlines.
We’ve seen the consequence of this in oil markets in recent months. Conventional wisdom said these would always stay at $100/bbl. And now people in the real world are having to pick up the pieces from this mistake.
Signs of stress seem to be appearing in the US housing market once more. Thus the Wall Street Journal reports:
“An estimated one in seven appraisals conducted from 2011 through early 2014 inflated home values by 20% or more..Bankers, appraisers and federal officials in interviews said inflated appraisals are becoming more widespread as the recovery in the housing market cools.”
The problem is that recent price rises have been driven by investors, not actual home buyers, as RealtyTrac warned back in July:
“When we look at our data, it’s clear that the home price recovery has been largely driven by investors and other cash buyers. As those investors and cash buyers slow down their purchases, the big question becomes, will demand from owner-occupant buyers be enough to keep the sales and prices moving higher?”
Today, it seems clear their concern was well-founded. As the chart shows, latest data for the S&P Case-Shiller Index suggests prices began to plateau in June. Seasonal trends may well cause them to gently weaken by year-end.
US HOME PRICES STILL TOO EXPENSIVE FOR FIRST-TIME MINORITY BUYERS
The problem is that the investor buying spree means prices are now too high for many potential first-time buyers, as the second chart shows.
The reason is that the US now effectively contains two distinct racial groups with very different profiles:
- Whites earn $42k/year and have median age of 42 years: Asians earn $49K and have median age of 37 years
- Blacks earn $33k and have median age of 33 years: Hispanics earn $30k and have median age of 28 years
- There are 84m white and 6m Asian households: there are 14m Hispanic and 16m Black households
Superficially, the average ratio seems reasonable at 7.6x earnings, close to the 7.4x ratio for Whites. But the Whites are mainly ageing BabyBoomers, who are moving beyond their peak home-buying period. Often, they are moving back to the cities and buying cheaper multi-family apartments instead of single homes.
The younger Black and Hispanic households have instead to do the ‘heavy lifting’ on home buying. But:
- Median earnings for Blacks are around 20% less than for Whites, and 25% less for Hispanics
- Thus the average home price/earnings ratio is 9.4x for Blacks and an eye-popping 10.1x for Hispanics.
In addition, 8% of Hispanics and 12% of Blacks are unemployed, versus only 5% of Whites. Thus first-time home buyers have been a declining part of the market since 2010:
- Their share was around 40% of the market in the earlier 2000s, and jumped to 50% in 2010 as house prices fell
- But since then it has been falling steadily, and is now just 33% – the lowest level since 1987
- Similarly, new mortgage lending is now at a 13-year low
- And new home sales since 2009 have been running at levels not seen since 1982
The rising amount of fraud in the house price appraisal system is thus a warning sign that the fundamentals of the US housing market are weakening once more.
Be very careful what you wish for. That is the key message coming out of close analysis of China’s latest trade data.
Recent media reports were upbeat at news that China’s exports had increased, as it appeared to suggest Western demand was returning. But it seems nothing could be further from the truth.
One major concern is that part of the increase was due to the final convulsions of the collateral trade, as I will discuss tomorrow. Property developers are clearly making last desperate efforts to raise cash by any possible means
A second critical issue is that the data confirms that China is now becoming a major exporter of high value products, such as PVC and PTA, for the first time in history.
CHINA IS BECOMING A MAJOR EXPORTER OF PVC
PVC highlights the change underway, as data from Global Trade Information Services shows. PVC is one of the world’s major plastics, used in drainage pipes and windows by the construction industry. As recently as 2009, when its stimulus programme began, China was the world’s largest importer.
Its net imports in 2009 totalled nearly 1.5 million tonnes, coming mainly from Asia and the US. But since then it has been busy expanding its own production. By 2012, its domestic output had jumped 70% from 9MT to 15.25MT. As a result of this, and the start of the housing market slowdown, its 2012 net imports halved to 665kt.
Since then, further major change has taken place as the chart shows, based on January – September data:
- Critically, China is no longer a net importer of PVC
- Its total imports have fallen to just 608KT in 2014 (red column) versus 816kt in 2012 (blue column)
- Its total exports have risen from 285KT to 949kt over the same period
- As a result, it has become a net exporter of 341kt
This change in policy by China was confirmed a year ago at the 3rd Plenum. And its impact has been building since May.
- The big loser so far has been the USA, despite its cost advantage due to shale gas developments
- China’s imports from the US are already down 34% versus 2012 levels
- And at the same time, China has been gaining export market share, partly at US expense
- It has sold 364kt into India so far this year and 175kt into SE Asia
- Exports to the Former Soviet Union have doubled from 124kt in 2012 to 277kt this year.
It also seems highly unlikely that China will change course. Most of its PVC production is coal-based, and it is strategically important for the country to maximise use of this resource, given its wider energy deficit. PVC production also maintains employment in the coal regions – which is critical for social stability.
PTA DEVELOPMENTS CONFIRM THE TREND TO EXPORTS
Developments in PTA, the raw material for polyester, confirm the major change now underway:
- China was importing 6.5MT of PTA as recently as 2011, but volumes more than halved to just 2.76MT in 2013
- In January – September 2014, import volumes have more than halved versus 2013 to under 1MT
- China has also begun exporting PTA for the first time in history, with volume of 340kt by September
- On current trends, China could also be a net exporter of PTA by this time next year
Companies and investors seem so far to have preferred to ignore these developments. But China’s drive towards self-sufficiency is unlikely to reverse. And social stability means it has to replace its lost export-oriented jobs in low-margin textile and other industries via a move up the value chain.
Thus very soon, one suspects, the Western media will be reporting howls of pain instead of cheers as China’s export surge continues.
The blog’s new Research Note in the ‘Your Compass on China’ series highlights the way that China’s commodity imports have been used to finance its housing bubble. This is clearly a shock for investors, who have till now believed the imports were a sign of its superior economic policies and long-term growth prospects.
The Qingdao probe could thus become the straw that breaks the camel’s back for world markets. There are two reasons to believe this is a serious threat:
- Investors have assumed that China’s vast share of global commodity demand was due to its economic growth. Now they will slowly wake up to find it was more about supporting a housing bubble
- Similarly, they have assumed that China had become ‘middle class’ with Western living standards and incomes. Now they will be forced to realise that consumer spending has been driven by the ‘wealth effect’
The worry is that the global financial system is currently priced for perfection. and may not be resilient enough to cope with this shock. Investors, companies and individuals have been lulled into believing that central banks’ experience with the Lehman Bros collapse means they will never let markets suffer a major downturn:
- Borrowing to buy stocks in New York is at record levels
- Investors Intelligence US sentiment index at 62.2% is at danger level, above August 1987 and October 2007
- American investors so-called ‘fear index’, the VIX, is at its lowest level since 2007
The best view is always from the top of the mountain, and thus it is no surprise to see Goldman Sachs still bullish:
“If nothing unexpected upsets the stock market’s delicate balance at these lofty heights, VIX could fall to record lows.”
The Qingdao probe is exactly the type of ”unexpected” event to reveal this as simply wishful thinking. The key issue is that a large part (we don’t yet know how much), of China’s vast purchases of commodities since 2009 has not been used to build the economy. Instead, it has been used as collateral to finance a huge property bubble.
China’s new leadership clearly understand this. As the blog discussed in its February Research Note, they are now implementing a series of well-designed policies with the help of the World Bank to limit the damage from the bubble’s collapse. We can only hope they are successful.
Now, however, the rest of the world is about to discover what they already know. The blog’s fear is that this discovery will prove extremely painful, because of being so “unexpected”.
A core reason for concern is the total size of China’s corporate debt. It overtook the US in 2013 at $14.2tn, according to ratings agency S&P:
“China’s corporate issuers account for about 30% of global corporate debt, with one-quarter to one-third of it sourced from China’s shadow banking sector. That means as much as 10% of global corporate debt, about $4tn to $5tn, is exposed to the risk of a contraction in China’s informal banking sector.”
China’s ‘collateral trade’ is at the heart of the issue. This is why the Qingdao probe is potentially so earth-shaking:
- Already some lenders are withdrawing from commodity financing in China as the risks rise
- Global market prices for copper and iron ore are declining, as informed players exit the market while they can
- The Economist notes that China’s banks are starting to become more reluctant to grant letters of credit
An investigation by the Wall Street Journal (WSJ) makes the link between the ‘collateral trade’ and housing very clear,. It appears the owner of the company at the centre of the Qingdao probe was heavily involved in real estate development:.
“In 2008, China’s government unleashed a $4 trillion stimulus package aimed at helping the economy withstand the global financial crisis. The stimulus drove a wave of credit through China’s financial system that launched a building boom in cities like Qingdao.
A real-estate company controlled by Mr. Chen currently is developing at least four projects in Qingdao, including a residential project called “Brocade City” and a large mixed-use development in the city center, according to the firm’s website.”
The WSJ adds that Mr Chen was not unique:
“Just about every trader who does collateral financing is also likely to have a real-estate development on the side, because the property sector gives higher returns,” said Jerry Chen, a metals trader at Shanghai-based Star Futures.”
It is already clear that China’s property market is entering a major slowdown, with Beijing sales down 35% so far this year. This will itself prove an enormous shock as property has been a money-making machine till now, with prices doubling every 2 to 3 years since urban property was privatised in 1998.
As property prices now fall, the ‘collateral trade’ will come to an end. In turn, investors will slowly realise that China’s economic growth has indeed been tied to a property bubble which is now beginning to burst.
There is thus a serious risk that today’s warning tremors in Qingdao will become a serious earthquake, and open fault-lines across the global financial system. Investors may now find out the hard way that central banks have instead created a debt-fuelled ‘ring of fire’, with China’s property bubble at its epicentre.