The strength of the housing sector is one of the leading indicators for the strength of the economy as a whole, and this summer it’s flashing a potential warning signal.
Other recession indicators, however, still mostly give a green light for the economy.
Housing Prices and the TSP
With stocks, bonds, and housing valuations all at historically high levels, the ratio of average household net worth to disposable income is higher than it ever has been in the United States:
Normally, the ratio of average household net worth to disposable income is around 5.5x or less. During the Dotcom bubble it temporarily peaked at around 6.1x, and in 2007 prior to the financial crisis it peaked at about 6.5x. Currently it’s over 6.8x.
The average price-to-earnings ratio of stocks is high, the price of bonds relative to the interest they pay is high (resulting in low interest yields), and housing prices remain elevated.
However, recent reports show that record high housing prices in Southern California, where some of the nation’s highest real estate valuations can be found, is causing sharply reduced home sales. Total sales of houses and condos dropped by 11.8% this summer compared to the same period last year, and sales of newly-built homes sharply dropped by a whopping 47%. Fewer companies are building new houses, and fewer people are buying these expensive new houses.
More broadly, reports from late July showed that nationwide housing demand in June 2018 fell by 9.6% compared to June 2017, which is the biggest decline in over two years.
This is worth watching for the TSP because home sales are historically a leading indicator for homes prices, and a leading indicator for economic and stock market strength as a whole. When prices start to outpace income too much, people start cutting back on buying property, property prices start to fall, banks become more stringent with their lending standards, and people cut back on expenses elsewhere as their net worth takes a hit, and stock valuations decline.
With the nation’s housing prices at record levels, declining home sales are certainly something to keep an eye on, and consumers would do well to be cautious about how much money they spend on a new home currently. It’s a good idea to maintain plenty of cash liquidity, don’t buy more home than you comfortably can afford, and negotiate lower prices where possible.
The Brighter Outlook
That being said, the majority of recession indicators show that although we may be inching towards the later stage of the business cycle, we’re still not very close to a recession:
This chart from economist David Rice tracks 19 historical recession indicators, and it shows a fairly healthy picture for the time being.
Normal business cycles travel counter-clockwise around this chart, although not necessarily in a smooth way.
The top right quadrant is a full-on expansion, where the economy is growing and the rate of growth is accelerating. The top left quadrant is a late-stage declining expansion, where the economy is still strong, but the rate of growth is shrinking and starting to turn downward. The bottom left quadrant is a recession, where the economy shrinks and things worsen. The bottom right quadrant indicates a recovery, where the economy is still in bad shape but is beginning to stabilize.
And right now, the average of 19 variables show that we’re still primarily set between the expansion quadrant and the late-stage decline quadrant. The mean of coordinates (MoC) of all the variables is still a healthy distance away from where it was shortly prior to the beginning of the 2007 and 2001 recessions.
Lyn Alden is a financial writer and an engineer, and holds a bachelor’s in engineering and a master’s in engineering management, with a focus on financial modeling and resource management. She specializes in analyzing and presenting financial data. Her investment work can be found on LynAlden.com.
