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Monday Morning Quarterback
(Monday, July 4, 2022)
Let me first establish my bona fides by acknowledging I’m fiscally conservative, but socially liberal. By this I mean I am pro-choice and believe in a woman’s right to an abortion. For God’s sake, it’s her body – not the government's. It’s her decision, not the government’s. As such, I was disappointed and disheartened by the Supreme Court’s decision last week in Dobbs vs. Jackson Women’s Health Organization. Now that I’ve clearly stated my position, let me reluctantly admit that as an attorney, it was the right decision for the right reason. But before you start screaming, please allow me to explain. Let’s start by acknowledging that the United States Constitution is an amazing document. It was written in 1789, and yet, it still works today, over two hundred and thirty-three years later. In its simplest terms, it provides for certain “substantive rights,” such as life, liberty, happiness, privacy, due process, while also focusing on specific issues such as guns, voting, immigration, interstate commerce, and taxes. Why these issues? Because these issues were relevant in 1789. Abortion was not relevant in 1789. Nevertheless, the Constitution is flexible and provides in the 10th Amendment that any specific issues not addressed in the Constitution are left to the states (“Federalism”). And like it or not that is how our government is structured. (If you don’t like it, why didn’t you speak up in 1789?) Anyway, getting back to abortion, the court made a fundamental mistake in 1973 with Roe vs. Wade. Under social pressure, the court struggled to legalize abortion by incorrectly squeezing a square peg into a round hole, holding that abortion is a “substantive right” under the due process clause of our Constitution. But that was incorrect. Our founding fathers (unfortunately all men) never considered abortion in the Constitution (nor after). In fact, it is never mentioned in the Constitution. So it is not a substantive right. In truth, the court should have held that the “right to privacy” (which is in the Constitution) should apply to a woman’s right to chose. But they never addressed that rationale. So the ruling in Roe vs. Wade was the right result, but for the wrong reason. And remained wrong for the past 50 years! So what the court did last week was correct a Constitutional wrong. We certainly don’t like the end result, but all is not lost. Remember, our Constitution says any rights not established in the Constitution are to be decided by the states. So now, like so many issues in our hopelessly divided country (i.e. marijuana, voting rights), some states will allow abortion while others will deem it illegal. Going forward, our best response is to support the states that preserve a woman’s right to choose. But wait a minute. What is more disconcerting is Clarence Thomas’ concurring opinion. In it, Judge Thomas suggests that other rights (such as birth control and gay marriage) should also be re-visited by the Court (conveniently ignoring inter-racial marriage). Now that scares the hell out me because that indicates this court is not finished.
Housing Starts Declined in May. The housing market is composed of three data points: housing starts, new home sales, and existing home sales. Let’s look at all three this week, starting with housing starts. Housing starts posted the largest monthly decline since the early days of the pandemic in May as builders continued to navigate a challenging housing market characterized by the highest mortgage rates since 2008, labor shortages, and ongoing supply-chain issues. That said, part of the 14.4% decline was the result of April's reading on construction being revised up to the highest level since 2006. Without that upward revision, May's decline would have been a more modest (though still significant) 10.2%. Looking at the details, both single-family and multi-unit construction contributed to the drop in May. It's clear developers are becoming more cautious about future demand for new projects with 30-year mortgage rates nearing 6%. However, it also makes sense to slow down the pace of starts given how many projects are currently sitting in the pipeline. The number of homes already under construction is at the highest level on record back to 1970. Moreover, the gap between the number of units under construction and the number of completions of new homes remains at record high levels back to 1970s as well. These figures illustrate a slower construction process due to a lack of workers and other supply-chain difficulties. In this context, it's not surprising to see new building permits fall 7.0% in May. The backlog of projects that have been authorized but not yet started is currently sitting just below the record high since 1999. With plenty of future building activity waiting to get underway as other projects are finished, and given that residential investment is counted in GDP when units are completed, housing can continue to be a tailwind for economic growth even with a slowdown in the headline pace of housing starts given current conditions. Builders are still looking to boost the near record-low levels of inventory to satisfy buyers, and as Millennials continue to enter the housing market as the now largest living generation.
New Single-Family Home Sales Increased in May. So far, the widely predicted demise of the US housing market has been exaggerated. Sales of new homes broke a four-month losing streak in May, posting a 10.7% gain to easily beat consensus expectations. Moreover, sales in prior months were revised up as well. Using April's original reading of 0.591 million, this week's headline gain would have been 17.8%. While it's too early to tell from just one month, the housing market may be beginning to find some footing amid declining affordability, with this increase marking the first gain so far in 2022. While rapidly rising prices have been an issue in the housing market throughout the COVID-19 pandemic, 30-year mortgage rates now sit at around 6%, adding to the burden. Assuming a 20% down payment, the rise in mortgage rates and home prices just since December amount to a 40% increase in monthly payments on a new 30-year mortgage for the median new home. That makes today's headline number even more impressive. Also keep in mind that new home sales are a very timely barometer of the housing market because they are counted when the contract is signed, rather than when the contract is closed, like with existing homes. That said, if the Federal Reserve is hoping to get housing inflation under control through higher interest rates, the progress has been slow. While median sales price growth has decelerated from a year-over-year peak of 24.2% in August, prices were still up 15.0% in the twelve months ending in May. The main problem is still that buyers are stuck dealing with very few options when it comes to completed homes, and demand remains high. It's true that overall inventories have been rising recently and now sit at the highest level since 2008. However, almost all of this inventory gain is from homes where construction has either not yet started or is still underway. Doing a similar calculation with only completed homes on the market shows a months' supply of a meager 0.6 (near the lowest level on record back to 1999). The good news is that builders have been ramping up construction activity to help meet demand, with the total number of single-family homes under construction at the highest levels since 2006. In time, that added supply will facilitate more sales while continuing to slow the pace of new home price appreciation. Ultimately, I think the market will to be able to weather the headwinds of higher mortgage rates in 2022, with sales of new homes only slightly down versus 2021.
Existing Home Sales Declined in May. Existing home sales fell for the fourth month in a row in May, hitting the slowest pace since 2020. Recent volatility shows that the housing market is struggling to find its footing so far in 2022, with falling affordability playing a major role. The prime culprit recently has been 30-year mortgage rates, which have already risen more than 200 basis points since December and now sit above 6% for the first time since 2008. Even more notable than the decline in sales in the report is that despite surging mortgage rates median prices are still climbing, posting a fourth consecutive monthly gain in May. Part of this is just seasonality (prices typically rise heading into the summer buying season), and median price growth in the past year has slowed to 14.8% from a peak of 25.2% in May 2021, but the "reverse wealth effect" the Fed has been looking for has yet to show up in the housing market. Assuming a 20% down payment, the rise in mortgage rates and home prices since December amount to a 45% increase in monthly payments on a new 30-year mortgage for the median existing home. No wonder sales have slowed down! Although the months' supply of existing homes for sale (how long it would take to sell today's inventory at the current sales pace) rose slightly to 2.6 months in May, inventories are still down 4.1% from a year ago. What is really impressive is that despite the lack of options demand remains strong, with buyer urgency so high in May that 88% of existing homes sold were on the market for less than a month. While sales are clearly under pressure, this is not a repeat of 2008/9. I do not foresee a collapse in home sales even with higher mortgage rates, though it is likely that existing home sales wind up moderately lower in 2022 than 2021. More inventory is becoming available, though more slowly than economists would like (for details see my report on housing starts above), which will eventually help price gains moderate further. Also keep in mind that Millennials are now the largest living generation in the US and have begun to enter the housing market in force, which represents a demographic tailwind for sales for the foreseeable future.
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