October saw a great deal of volatility in financial markets as concerns about rising yields gave way to a push-and-pull between stocks and bonds. This dynamic is emblematic of the late cycle. In the latter part of the business cycle, growth is still strong; consumer spending and business investment are strong, but early signs of inflation begin to show. Prices begin to rise as demand outpaces supply because the economy runs into capacity constraints. At this time, the central bank begins tightening policy. The cycle reverses itself when tight monetary policy, combined with high debt burdens, causes spending to slow.
Financial markets participants have been watching closely for signs of this slowdown. For the most part, growth still seems relatively robust: consumer spending and sentiment are still strong and business investment, though off highs, remains elevated. However, housing has shown some early signs of slowing. Supply of new homes on the market (below, left) spiked in recent months, to the highest level since 2011. At the same time, existing and new home sales (below, right) have been declining, suggesting lower demand.
This slowing in home sales can be partially attributed to tighter monetary policy. Higher borrowing costs have made purchasing homes more expensive. Below, the 30 year treasury yield (to which mortgage rates are benchmarked), have risen precipitously in H2 2018.
As a result, housing starts have flattened out, and homebuilders equities have declined precipitously in 2018.
Housing is a particularly important pocket of U.S. economy. First, a slowdown in housing likely signals impending spending weakness, as consumers forgo buying new home goods and supplies (durable goods such as washing machines, furniture, etc). Additionally, as housing prices slow (and as stocks decline), credit creation slows as consumers become less “rich” on the margin. As a result, spending decreases, sowing the seeds for a downturn.
All this being said, the U.S. growth outlook is still fairly sanguine, and housing’s impact to growth is likely to materialize with a lag. More likely to shock the business cycle are secular tariff risks. However, as we continue through the late cycle, a slowing of housing activity continues to build the case for defensive positioning.
