Who Needs Economists When We Have the Home Builders?
by Brian Pretti CFA, Contrary Investor. January 23, 2009
I mean really! As you know, plenty of very highly paid Street economists at many a major brokerage or banking firm got it dead wrong over the last few years. Not just a little bit off, but dead wrong! “No one ever could have seen this coming.” How many times have you heard that one over the last few months? C’mon, anyone who is even a semi-serious student of credit and economic cycles saw “this coming” a mile away. In fact, personally over the last few years I have been relying in part on the homebuilders of this world to tell me exactly what was to come ahead, and they have obliged significantly. Thanks guys (and gals). And sure enough they have been dead right. Not close, but dead right.
Probably nine months back or more we were telling folks a very meaningful decline in consumer spending was coming full speed ahead and would not be denied. We were counseling folks that a massive cliff like drop in industrial production was just about to take the consensus by big time startling surprise. And we were expecting domestic labor market conditions to weaken very meaningfully. How were we so sure these events were to transpire? Simple, the homebuilders were telling us loud and clear. No equivocation. No on the one hand and then the other hand commentary. Loud and clear and with graphic realism. I’ll show you exactly what I’m referring to and suggest you pay attention as we move ahead. Ignore these folks at your investment peril.
As you probably know, the wonderful folks at the National Association of Home Builders put out a monthly survey directly asking those in the industry just how they feel about life in the super duper world of residential real estate. This is a diffusion index, meaning that readings above 50 tell us the preponderance of responses were positive, and vice versa. As of the latest January data that hit the tape on Wednesday of this week, this crowd is feeling pretty darn bad. In fact, as bad as they have ever felt in the entire history of this data. See what I mean?
That’s not fun, right? Unfortunately given the very somber tone of the residential real estate industry these days, this is not new news by any means. In fact, I believe this survey has been dismissed by many as most assume they already “know” the tone it will reflect. Why check in on further bad news when there’s already so much to go around, no? I’ll leave you with the proposition that taking your eye off what the homebuilders have to say about life is a very big mistake. They absolutely helped show me the light as to what was to come in so many parts of the real economy. And I believe that will continue to be the case ahead. I’m watching and listening.
Okay, the big punch line here is that the NAHB survey has been a very valuable leading and corroborative macro economic indicator for literally decades now. I’ll show you exactly what I mean in the charts below. What you see below is one of the reasons I was so certain a plunge in consumption and production, as well as continued labor market weakness was a virtual certainty in the latter part of last year. All one had to do was humbly listen.
As is really the directional and corroborative case in all of the relationships below, the NAHB survey is very highly directionally correlated with consumer spending. Real personal consumption trends of course are the GDP report’s way of capturing inflation-adjusted consumer spending. THE key issue is the very high degree of correlation over time.
As of early 2008, the NAHB survey was in full plummet mode. But the year over year change in real personal consumption expenditures had not declined… yet. Of course fast forwarding to the present and with the clarity of hindsight, we now see the homebuilders were pointing exactly at what was to come with consumer spending.
As you look at the chart above, the keynote feature is that the NAHB survey in prior cycles has bottomed exactly with or literally just prior to key turning points in the tone of real consumer spending. Not too hard to figure out as real estate values are certainly tied to the psychological wealth effect embodied in consumer spending.
Fine, tying real estate prices to spending is almost common sense. C’mon, impress me with the clairvoyance of the homebuilders, Okay? Now that you asked, why sure. How about tying what the homebuilders have to say to industrial production? You asked for it.
Once again, THE key issue here is a high level of directional correlation. As with consumer spending, the NAHB survey was plummeting a year back but the year over year change in industrial production at the time was stable and growing. Little did the consensus expect industrial production was about to fly nose first into the proverbial tarmac, setting a new annual rate of change low for the period observed (exactly as has been the case with the new low in the NAHB survey). Are you a believer yet? If not, you now have two more tries.
You get the picture by this point, I’m sure. Do I really have to explain this directional linkage again? Good, I didn’t think so.
New lows on the NAHB survey and new lows in the consumer confidence readings.
This is where it comes to a dramatic conclusion for this little analytical exercise. Once again, the homebuilders knew what was to come.
In fact, one of the really neat character points here is that at each peak and trough cycle interval with the rate of change in payroll employment, the NAHB survey led the way. No exceptions. We see virtually the same thing with the historical consumer confidence data.
You don’t need me to go on and on. We need to watch what the homebuilders have to say about life. Don’t forget these folks as their “calls” on the economy that is essentially the directional rhythm of their ongoing monthly surveys make many a headline Wall Street economist look like amateurs. Historical directional correlation here is far too high to be ignored. THE important issue to our investment decision-making ahead is to look for a true and sustainable turn up in builder sentiment. In fact, when it ultimately arrives, I expect most folks will dismiss it as wishful thinking. As for me, I promise I will not.
© 2009 Brian Pretti