Introduction
Starting with the bursting of the technology bubble in 2000, the fortunes of the US economy have waned. Since then, the US has seen two recessions with the last being the worst since the 1930s, a rising trend in unemployment, the bursting of a corporate debt bubble with the tech wreck and the bursting of a housing debt bubble with the sub-prime mortgage crisis. So it’s little wonder the US share market has been spinning its wheels in a secular bear market. Some commentators even talk of a permanent decline for the US.
The high level of US public debt, ongoing private sector deleveraging, less business friendly policies, demographic trends and the absence of extreme share market undervaluation suggest the secular bear market in US shares may not be over yet. That said, it would be dangerous to write the US off. Many did this in the 1970s only to see it roar back with vengeance in the 1980's and 90's .
More importantly, there are some signs of light at the end of the tunnel for the US in manufacturing, oil production and housing. This note takes a look at these sectors, focusing on the latter as housing was the original driver of the global financial crisis.
US manufacturing renaissance
Recently there have been numerous examples of companies setting up manufacturing plants or expanding production in the US over locations in Canada, Mexico, Japan or the emerging world. These include Maserati, Toyota, Honda, Nissan, Kia, Intel, Whirlpool and Caterpillar. In fact for the first time in over 35years, annual growth in manufacturing employment is exceeding employment growth elsewhere in the US economy. The key drivers of America’s manufacturing renaissance are restrained unit labour costs in manufacturing (which have been unchanged for the past 30 years), rising wages in emerging countries, the low US dollar (US$) after a decade long slump, and cheap energy prices helped by surging natural gas supply. While it’s early days yet, America’s manufacturing renaissance has further to go.
Surging oil production
US natural gas supply has been surging for years resulting in low prices. More significantly, a few years ago US oil production quietly bottomed and is now on the rise again thanks to a surge in shale oil production. The US has huge reserves of shale oil and advances in fracking technology (by which shale kilometres below the surface is fractured using explosives, allowing oil to be released and flow to the surface) and oil prices around US$100 per barrel are making it economic for these reserves to be tapped. Some even see the US becoming self sufficient in oil again in the decades ahead.
US housing bottoming
A collapse in the US housing sector was at the core of the sub- prime mortgage crisis in the US which subsequently morphed into the global financial crisis. US house prices and housing construction surged into the middle of the last decade as lax lending standards underpinned a huge surge in home ownership. Boom turned to bust, starting around 2006 as housing supply started to surge and it became harder for sub-prime borrowers to refinance their loans. Foreclosures rose, made worse in turn by rising unemployment as the whole process fed on itself. The subsequent slump has seen a 34% plunge in house prices. This has seen the volume of private residential investment collapse by about 60% from its peak in the mid 1990s, resulting in a huge drag on US gross domestic product (GDP) growth.
Why the worst is likely over for US housing
There are good reasons to believe that the US housing market is bottoming and starting to recover.
The first thing to note is that most US housing indicators have stabilised. Home sales have been bouncing along a bottom since 2009. Housing starts and permits to build new houses have been bottoming since late 2009. Furthermore, the National Association of Home Builder’s conditions index has now broken out on the upside, pointing to a rise in starts ahead.
Second, the number of vacant homes is now starting to fall sharply. Over time the equilibrium number of vacant homes has increased in line with the rising population. This is proxied by the long-term trend line in the next chart. It can be seen that the gap between the actual number of vacant homes and its long-term trend is now closing rapidly. Related to this, household formation is likely to rise sharply. Since 2006 it has been running well below that implied by population growth and has collapsed from a record 2 million to around 700,000 last year. This reflects tough economic conditions causing young people to stay at home with their parents for longer and is likely to rebound as economic conditions improve. If the number of vacant homes continues to decline at the same rate as the last couple of years and household formation picks up then the overhang of housing will likely be gone by year end.
Third, the stock of unsold new homes has largely vanished. It is now at its lowest level since the 1950s. This seems more extreme when it is compared with the fact that the US population has more than doubled since then.
Fourth, while the US mortgage foreclosure rate remains high, the delinquency rate is slowing as are the number of new foreclosures, pointing to a decline in foreclosures ahead.
Finally, housing affordability has reached a record level. While this has not been acted upon given the excess supply of housing and tough economic conditions, we are likely to see greater demand for houses as the excess supply dwindles and economic conditions improve.
Similarly, house price to income and house price to rent ratios have collapsed, pointing to good value in US housing.
The improvement in US house price valuation measures stands in stark contrast to the still very overvalued Australian housing market…but that’s a different story. Note both the US and Australian charts use OECD data for consistency.
The bottom line is that the US housing market appears to have bottomed with recovery in both activity and prices likely.
What a recovery in US housing would mean?
A recovery in US housing has several implications.
- First, by reversing a significant drag on the US economy it should help perpetuate economic recovery.
- Second, this is likely to be reinforced by a boost to US household weatlh as house prices stailise and recover.
- Third, residential construction is a key user of raw materials like copper, therefore a recovery in US housing construction should boost global commodity demand.
Concluding comments
While the secular bear market in US shares that began 12 years ago may have further to go, there are a number of positives suggesting there is light at the end of the tunnel. In particular the US housing sector appears to be bottoming. This is an important investment theme, but is difficult to play from Australia. Magellan and Platinum Asset Management have their portfolios positioned with this information in mind.
Taken from an article written by Dr Shane Oliver, Head of Investment Strategy and Chief Economist - AMP
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