Earlier this year, we forecasted that volatility would return, and indeed it has. Equity market turbulence and interest rate volatility have characterized much of 2018. In this type of environment, navigating through the noise of headline-related concerns is critical to identifying opportunities and avoiding areas of the market that can exacerbate downside risk. It is also important to maintain a long-term mindset.
One of our central investment themes this year is that residential mortgage debt is still early in its cycle versus corporate credit. On the surface recent housing-related headlines seem to challenge this view. Home price appreciation has moderated, new and existing home sales have cooled off, and housing starts have exhibited volatility (Figure 1). While these data points may seem worrying, we believe that there are several dynamics for investors to consider before overly indulging in the alarming headlines of recent months.
Figure 1. Should recent headlines about the housing market be a concern?
Source: Federal Reserve and Bloomberg. Home prices as represented by the Case Shiller House Price Index and as of August 31, 2018, New Home Sales as represented by US New Single Family Houses Sold Annual Total SAAR as of September 30, 2018, Existing Home Sales as represented by US Existing Home Sales SAAR as of September 30, 2018 and Housing Starts as represented by Annual US New Privately Owned Housing Units Started by Structure SAAR through September 30, 2018
First, the recent slowing in home values, sales and pick-up in supply volatility after a prolonged period of growth tells us that the post-crisis, U.S. residential mortgage market has heeded its hard-earned lessons. Put another way, cooling off periods such as this are meant to happen in order to prevent the sort of bubbles that formed in the run-up to the Financial Crisis. With price growth tightening its range, sales tapering and the flow of new supply potentially aligning more with demand, we believe the housing market is simply rediscovering a more normalized, more traditional expansion cycle. We believe this expansion should resume as seasonals improve and wage growth continues to be a tailwind behind Americans’ quest for home ownership.
As importantly, borrower fundamentals remain firmly intact. As Figure 2 shows, delinquency rates and foreclosures have steadily eased off their respective crisis-aftermath peaks.
Figure 2. Borrower fundamentals remain strong
Source: Federal Reserve, Bloomberg and Mortgage Bankers Association. Data through June 30, 2018
In addition to the improved overall housing market mechanics, the improved broader macroeconomic backdrop is another critical component supporting the U.S. residential lending environment. Since 2007, the U.S. population has grown by 26 million, the U.S. labor force by 8 million, and the number of households and nonfarm payrolls by 9% and 7% respectively. Furthermore, at $19 trillion (and growing) U.S. gross domestic product is 34% higher than it was in 2007. Each of these measures point to additional firepower that has accrued in the U.S., providing dry powder for the housing market to continue its expansion. And, with the unemployment rate safely below 4% and wage growth trackers now reliably registering over 3%, income growth has re-emerged as another arrow in the US consumers’ proverbial quiver.
So while housing-related headlines may suggest something more ominous, we believe investors should re-focus on the data, which conveys a housing market cycle that is simply normalizing to a sustainable pace. Going forward, its resilience will be supported by a sound U.S. mortgage market and supportive macroeconomic backdrop.
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