Can the US housing market avoid a material slowdown?
This year’s change in the US 30-year mortgage rate from around 3.3% to recently 6% has a caused a dramatic fall in mortgage applications with the 12-week average now in the 5% percentile since 1990 suggesting housing activity is slowing fast. Several real estate brokers have recently laid off employees in an anticipation of declining activity.
Lennar, the second largest US homebuilder, has just reported FY22 Q2 (ending 31 May) earnings with revenue at $8.4bn vs est. $8.1bn as the homebuilder is still enjoying the tailwind from previous orders. More impressively the gross margin improved 340 basis points to 29.5% suggesting good cost management amid cost pressures. New orders increased only 4% reflecting the dynamics explained above while the backlog rose 16% y/y and the backlog dollar value increased 33% to $14.7bn reflecting the inflation in construction materials and thus prices of new homes. Lennar’s new orders guidance for the current quarter is 16-18,000 vs est. 17,750, so demand is coming in weaker than estimated.
For homebuilders the situation is situation is even worse with Lennar’s share price down 44% reflecting revenue and profitability slowdown. Higher financing rates for homes while building material costs remain high coupled with a tight labour market are an awful cocktail making it less attractive to build a new home relative to buying an existing home. The 6-month average of US leading indicators has gone into negative in the latest print with the downward move accelerating suggesting the US economy will materially slow down over the coming six months. Whether it turns into a recession, or to what degree, is still uncertain but the probability is definitely rising.
Ironically it is the rising recession risk that is now cooling commodity prices and fading the momentum in interest rates reducing the pressure on equities. Historically drawdowns are not a continuous decline to the trough, but instead a stop-and-go sequence, and it is likely that unless adverse developments enter the equation that we could be in for a slightly more positive equity market in the weeks to come. The next leg down in equities to new lows could come from the fact that there is a natural limit to how high the nominal interest rate can go before the Fed will have to halt the tightening and thus allowing inflation to run hotter for longer which will likely cause headwinds for equities longer term.