It is is 10 years since the US subprime bubble began to burst, with disastrous results for the US and global economy.
The US Federal Reserve had created the bubble in the belief that higher house prices would boost the economy. It then made a bad situation into a disaster by refusing to accept that a bubble existed:
Alan Greenspan, then Chairman of the Fed, told Congress in June 2005, at the height of the bubble:
“Although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications”
Ben Bernanke, Greenspan’s successor as Fed chairman, then continued to argue that there was “no housing bubble to go bust”
Yet US housing starts have never returned to the 2.0 – 2.3 million/year level seen between 2003 – 2006. Last month, they were just half this level at 1.1 million/year.
The Fed’s failure has had important implications for US housing policy. Both President Clinton and President Bush had focused on increasing home-ownership. When Clinton’s 67.5% target was reached in 2000, Bush was keen to achieve higher levels. But instead, as the chart shows, ownership peaked at 69.2% in 2005, and then began to collapse as the subprime bubble burst:
It is now back at 62.9%, equal to the lowest level seen since records began in 1965
The trend is clearly downwards, and so it seems likely the rate will fall to new lows later this year
Housing therefore represents an excellent example of the importance of demographics in driving demand, rather than monetary policy. Since 2008, the Fed has taken interest rates to their lowest level in history, and printed money at an extraordinary rate, in order to create consumer demand.
But it has completely failed to restore the housing market to its former levels, for the simple reason that demand patterns are driven by issues of lifestyle and affordability – rather than just interest rates. As the second chart shows, housing starts have not only halved since their 2006 peak, but the type of homes being built has changed quite dramatically:
Today’s Millennials are not following their Boomer parents in wanting to buy McMansions in the suburbs
They have much higher debt levels due to the cost of tuition fees, and they are having fewer children
The recovery in house prices fostered by Fed policy has also reduced their ability to buy single homes
The Boomers themselves are also no longer so keen on suburban living, and prefer to be town/city-based
As a result, over a third of all new homes are multi-unit – twice the level seen in the boom years of 1990 – 2007
A new study from Corelogic confirms that affordability issues also impact existing homeowners:
Homeowners making moves out of state are increasingly selling out of expensive markets like California, where price escalation is steep, and buying into lower-cost markets such as Texas and Arizona. Overall between 2000 and 2015, 2.5 home sellers left California for every out-of-state buyer coming into the state”.
The US housing market thus confirms the profound changes taking place in Western demand patterns. It also highlights the risk of believing that the Fed is able to guide developments in its preferred direction. Or, indeed, of believing that the Fed has a good grasp of what is actually happening in the real economy.
Its not all fun being part of the US millennial generation (those born between 1980 – 2000). They number 80 million, about the same as the BabyBoomer generation. But as the New York Times notes:
- “The millennial generation has less wealth and more debt than other generations did at the same age, thanks to student loans and the lingering effects of the deep recession
- “Though millennials are hailed as the first generation of “digital natives,” the over-40 (and 50 and 60) sets have become pretty adept when it comes to smartphones and other devices”
In addition, the millennials are much more racially mixed than the older generation as Census Bureau data shows for the 15-34 age group.
- Only 58% identified themselves as White, compared to 78% of the Boomers generation at this age
- 21% were Hispanics (versus 7% of the Boomer generation); 6% were Asian (2% of the Boomer generation); whilst the proportion of Blacks was stable at 14% in both generations
- Immigration is a key reason for the increase in Hispanic numbers: 15% of millennials aged 20 – 34 were born in a foreign country, double the figure for the Boomer generation
This increase in racial diversity matters in terms of employment, and hence spending power. Bureau of Labor Statistics data shows that in Q1, only 3% of Asians and 5% of Whites were unemployed in the 25 – 34 age group, compared to 7% of Hispanics and 12% of Blacks. Equally important is that median earnings for Blacks are around 20% less than for Whites/Asians, and 25% less for Hispanics.
Importantly also, in terms of potential housing demand, nearly a third of all 18-34 year olds were still living with parents in 2014, up from just over a quarter in mid-2000.
DEMOGRAPHIC CHANGE HAS ECONOMIC IMPACT
These changes matter in terms of demand for basic chemical products, as the chart above of chlorine and caustic soda production from the American Chemistry Council (ACC) confirms.
The problem is that the higher-spending Boomer generation has been followed by lower-spending Millennials.
Volumes for both chlorine and caustic soda have thus drifted steadily lower over the past 20 years. Current volumes are actually lower than the lowest levels seen before 2008. And chlorine demand into PVC has been badly hit by the collapse of housing starts which are now less than half the peak levels seen in the early 2000s.
This has not been good news for producers, who had assumed there would be a major recovery in the US economy. They have also been disappointed by demand in export markets, as latest data from Global Trade Information Services shows:
- Average US export prices fell 22% in January – April versus 2013 to $168/tonne, whilst volume was unchanged at 1.6m tonnes. Overall volume was only maintained via a 40% cut in prices to just $126/t to Australia
- PVC markets (the main vehicle for chlorine exports) were even more difficult, with volume down 20% over the period and average selling prices down 15%
The second chart, based on Chlorine Institute data confirms the result of these trends in terms of capacity utilisation. Rates so far in 2015 have been in steady decline with 2015 averaging just 81% versus 83% in 2014 and 86% in 2013.
Similarly, the ACC report total chlorine volume is down 3% versus 2014, and caustic volume is down 4.8%.
Thus developments in the chloralkali industry highlight the critical importance of focusing on demand-related issues, rather than assuming that lower feedstock costs will automatically lead to success.
US housing starts are slowing so far this year, with February’s starts just below the million level again on an annualised basis. This follows the steadily declining rate of home ownership, which is now back at 1995′s level of 64%. And yesterday’s Case-Shiller report on home prices suggests the 10-City Index may well have peaked back in August.
The chart above looks at these developments in a longer-term context:
- It compares housing starts on the vertical axis with auto sales on the horizontal axis
- It is colour coded, so the years from 2000 – 2007 are in red, and the period since 2008 in green
- It confirms that housing starts remain well below subprime era levels: auto sales only caught up last year
- This weaker performance has occurred despite major support in terms of low interest rates and subsidies
2007 was the worst year in the early period. But it still managed 1.4 million starts and 16m auto sales. 2014 was the best year in the later period, but starts were only 1m, although auto sales matched the 16m level. And the best year since 2000 was in 2005, which saw 2m starts and 17m auto sales.
Equally worrying is that both markets are also showing clear signs of underlying weakness:
Both markets are critical to the US economy, and to the US chemical industry. The average car uses around $3.5k of chemicals, and the average new home around $15k, according to American Chemistry Council data.
Yet cars that are sold on 5 1/2 year leases won’t be replaced until the year 2020. And building multi-home apartment blocks typically requires only half the materials of a single home.
This weakness, combined with the impact of the oil price collapse, is confirmed by the Atlanta Federal Reserve’s new GDP Now index, as the chart shows. This aims to provide a real-time snapshot of US GDP. It was registering Q1 growth of just 0.2% on Monday.
US housing markets will never be the same again. That’s the conclusion of a new analysis by the blog for ICB.
The picture above of a typical US family from the BabyBoom days tells the story:
- The number of US babies born between 1946 – 64 increased by 50% versus the previous 18 years
- 4 million were born each year – and when they reached adulthood they then began to have children themselves
- Inner city race riots meant a ‘flight to the suburbs’ developed
- So demand soared for single family homes in a nice development with good schools
- If prices were too high in your first choice, you drove 10 miles down the freeway and paid $10k less
So demand suddenly switched from multi-family apartment blocks to single-family homes. And people needed to buy plenty of new cars so that they could get to work and provide a taxi service for the kids. Large out-of-town shopping malls were also essential, so you could fill up the car at weekends with everything you would need for the next week.
But now those days are over. Not only were fewer babies born after the Boom, but fertility rates have halved since 1955, to just 1.7 babies per woman.
Instead, the key demand driver is the aging population. Home ownership rates are in long-term decline, back at levels last seen in 1995.
So demand for suburban housing is never going to be the same again. Driving habits change with age, and as people get older, so they drive a lot less. Equally important is that city centres are now becoming increasingly attractive as places to live. As a result, a ‘flight back to the cities’ is well underway.
None of this is rocket science. But we seem to have got out of the habit of thinking about people as being the centre of demand. Yet we all know older people, maybe our parents or friends or work colleagues. All we have to do is to apply the learning from our own knowledge to understand what the future holds.
Please click here to download a free copy of the new ICB article.
And please click here to view the YouTube video interview with ICB deputy editor, Will Beacham.
Every now and then, the blog scratches its head and wonders, “what would it take to convince US policymakers that demographics have an influence on demand?”
Suppose, for example, they loudly and consistently announced that the US was now in full recovery mode, and would be certain to achieve economic growth of 3% or more? And that then, growth actually turned out to be minus 1% in Q1? Would that make them look again at their theories?
This of course is what happened last week. And so we know policymakers’ answer to the blog’s question. Just as feared in April, they chose instead to ”blame the downturn on the weather”. Yet Canada had just as cold a winter, and managed GDP growth of 1.2%.
ECONOMIC DATA SHOWS NO SIGN OF RECOVERY
But the Q1 data tells the rest of us that the US Federal Reserve was wrong to assume a strong economic recovery was possible. The core issue, as the chart shows, is that US GDP became over-dependent on personal consumption during the SuperCycle years:
- Personal consumption was less than 60% during the 1950s, but is now around 70% (blue line)
- Government investment was nearly 40%, but is now half this at 20% (green)
- Private investment moved up from 10% to 20% during the Reagan/Clinton years, but is now 15% (red)
- Net imports have only been recorded recently, and were neutral in the 1990s, but are now -3% (yellow)
Equally important is that the detail of the Fed’s GDP data shows that the key driver for GDP growth over the past year has been inventory changes. GDP grew at 1.9% in 2013 as companies built inventory in anticipation of recovery. When recovery failed to arrive, they had to reduce inventory again, taking GDP to -1% in Q1 2014
2 other features from the detailed quarterly GDP data are worthy of note :
- Consumer spending was relatively strong in Q1, up 2.09%. But this was not due to economic recovery: at least half of the gain was due to new healthcare spending as Americans signed up for Affordable Care coverage
- There was also a major downturn in US exports. These moved from a gain of 1.23% in Q4 2013 to a fall of 0.83% in Q1 2014. This hardly suggests a solid expansion is underway in the global economy
The only conclusion is that the Fed remains in Denial mode. This was confirmed by the topics discussed at The Fed’s policy conference last week, which focused on the risks of high inflation, even though key April statistics suggests recovery is as far away as ever:
- US consumer spending dropped in April
- Nearly half of all households expect their inflation-adjusted income to decline over the next 12 months
- Income growth slowed to just 0.2% in April, the weakest increase so far this year
- The main consumer sentiment index fell to 81, and remains at around half the levels seen during the SuperCycle
Even the Wall Street Journal, normally a strong cheerleader for the Fed, felt forced to express some doubts:
“Fed officials expect economic output, as measured by GDP, to expand by 3% in 2014, according to their March projections. Taking the Q1 contraction in output together with projections of Q2 growth between 3% and 4%, the economy appears once again to be expanding at a sub-2% annual rate over the first six months of the year…To achieve the Fed’s growth forecast, an even larger pickup in the second half will be needed.”
US HOUSING RECOVERY HAS STALLED
Equally critical is that the housing market – supposedly the motor for the recovery – has clearly stalled. Sales of single homes by banks (due to foreclosure or similar processes) are still running at twice the level of sales by home-builders – 5 years after the Crisis began. As the Financial Times reported:
“An unexpected slump in the US housing market has exposed the shaky fundamentals of recovery in the world’s largest economy, as a lack of incomes growth for middle-class Americans leaves them struggling to buy a home.
“Last week, Janet Yellen, the chairwoman of the US Federal Reserve, warned a risk that had seemed vanquished was once again menacing the economy. “The recent flattening out in housing activity,” she said in testimony to Congress, “could prove more protracted than currently expected.”
Thus the blog scratches its head, and wonders what it would take to convince policymakers that it is impossible for an ageing society, like the US, to return to growth levels seen when the population was in its prime wealth creation phase?
Is it simply that, as the saying goes, “there are none so blind as those that will not see?”
The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:
PTA China, down 10%. “Downstream polyester markets have been under pressure due to weak global macroeconomics and slower growth in demand in China”
Benzene, Europe, down 2%. “Offtake levels have only begun to recover following a ‘disastrous’ 2013 and European sellers struggle against lower global pricing.”
US$: yen, down 3%
Brent crude oil, flat
S&P 500 stock market index, up 5%
Naphtha Europe, up 3%. “ Demand from domestic petrochemical buyers remains stable, albeit at low levels”
HDPE US export, up 7%. “US prices are still somewhat too high to generate much interest from the global market”
US housing markets have been a disaster for many homeowners. Overall, they have lost $6tn since the collapse began in 2006. Nationally, prices are still down 32% versus their peak, according to the Case Shiller Index.
Temporarily, however, the market is continuing to stabilise. Banks have slowed the rate of foreclosure, and are wary of running into more trouble with regulators, after the ‘robo-signing’ problems of the past 18 months. But stabilisation is not the same as recovery:
• 11m Americans still owe more than their house is worth
• There are around 3.3m homes in ‘shadow inventory’
• These are either in the foreclosure process, or have missed payments for 3 months
• One in every 248 housing units had a foreclosure notice in Q3
On the more positive side, housing starts has begun to improve, as the chart shows. They jumped to 872k in September, with building permits also rising to 894k. These are easily the strongest numbers since the crisis began.
But the buyers are mostly not ordinary Americans seeking to buy a new home. Instead, the money is coming from investors seeking to rent out property to those now unable to buy. Many are private investors, buying locally. But private equity funds have already raised $7.2bn.
The driver, as Pimco (the world’s biggest bond fund managers) note, is that at least another 4m Americans will need to move into the rented sector, as foreclosures continue.