INSIGHT: ‘Something strange in the neighbourhood’ – the mystery of US housing market strength

NEW YORK (ICIS)–There’s “something strange in the neighbourhood”, UBS analysts channelling the 1984 Ghostbusters movie pointed out in a recent global macro strategy update. Surprising strength in the US housing market is being highlighted as one of its three key “risks” to its expected recession scenario.

• Surprising surge in US housing starts and new home sales
• Potential positive implications for housing-related commodities but no bounce in PVC yet
• High rates means lack of existing homes for sale
• First-time buyers being funnelled to new homes instead, at lower price points
• Latest housing spike may not be sustainable in longer run

Consensus has the US headed into recession later this year and the US Federal Reserve continuing to hike interest rates to tamp down inflation – likely by another 0.5 percentage points. Manufacturing is already in recession as consumers shift to services spending, and weakness is spreading to other sectors. So why is housing – perhaps the most interest-rate sensitive market – showing such strength?

It was a blowout report for US housing starts this week, with starts surging 21.7% month-on-month to a seasonally adjusted annual rate of 1.63m annualised in May with gains across both the single-family and multi-family segments. Starts were up 5.7% year on year.

This was followed by a report on US new home sales jumping 12.2% to a 763,000 unit pace in May, also well above expectations and up 20.0% from a year ago. Inventories of new homes eased 0.9% to 428,000, which was down 2.9% year on year. The median sales price of $416,000 was also down 7.6% from a year ago.

“The cure for higher prices is higher prices. Despite higher mortgage interest rates and tighter credit, lower purchase values aid affordability,” said Kevin Swift, ICIS senior economist for global chemicals.

“The housing downturn which began last spring may be stabilising and gives credence to a ‘rolling recession’ scenario,” he added.

In a rolling recession, individual sectors enter their own recession at different times and also recover at varying points.

POSITIVE IMPLICATIONS FOR CHEMICALS
If housing has indeed bottomed and is embarking on a recovery, this has major positive implications for chemicals and polymers.

Housing is a key end-use market for chemicals in the form of paints, wire insulation, house-wrap, sealants, roofing materials, resilient flooring and vinyl pipes and siding. New housing also generates sales of appliances, furniture, carpet, fixtures, and window treatments. In total, each start engenders on average over $13,000 worth of chemicals, according to Swift.

Key commodities leveraged to housing include PVC (pipes, profiles); MDI, polyols (insulation, furniture), phenol (resins for wood binders), along with TiO2, VAM and acrylates in the coatings chain.

PVC YET TO SEE IMPROVEMENT
Interestingly, polyvinyl chloride (PVC) – the polymer most exposed to the housing sector – has yet to show any signs of a recovery in the US or globally.

US converters of PVC pipe, siding and window profiles have yet to see a shift in demand and are lamenting the “missed” spring uptick. Overall, the US PVC market, of which 40-60% is pipe, remains “quite deflated”, said Joel Lindahl, vice president of Vinyls at Chemical Data (CDI), part of ICIS.

However, the US chemical stock most exposed to PVC and the housing market – Westlake – has vastly outperformed its peers in a difficult market.

Westlake not only produces PVC, but also PVC pipes and window profiles. In 2021, it further boosted its housing exposure with the $2.15bn acquisition of Boral’s North American building products business. This brought PVC and building products to over 50% of sales.

SOLVING THE MYSTERY
Major US homebuilder stocks such as Lennar, DR Horton and Toll Brothers have also been on a tear, hitting record highs, even amid high mortgage rates and relatively low affordability. The big moves came well ahead of improving fundamentals.

So what does the market see that is not yet reflected in demand for housing-exposed PVC and other chemicals?

There has already been over a decade-long period of underbuilding and thus shortage of housing supply following the Great Financial Crisis of 2008-2009. UBS housing analyst John Lavallo estimates that from the Great Financial Crisis to today, US housing has been underbuilt by 2.5m-3m units – about two years’ worth of starts.

Housing starts slowly recovered since the crisis and then cratered in the 2020 pandemic. With the Fed cutting interest rates to zero and the government spending trillions of dollars in stimulus, housing quickly recovered and peaked at 1.80m starts in April 2022.

As the Fed embarked on an unprecedented rate hike cycle to quash inflation, housing starts plunged to a low of 1.34m in both January and April 2023. Then came the surprising May spike.

LACK OF EXISTING HOMES FOR SALE
As mortgage rates shot up, homeowners are now choosing to stay put with their low interest rate mortgages, dwindling the supply of existing homes for sale. US existing home sales have plunged in the past year to 4.50m in May – down 20.4% from a year ago. This is only about three months of supply versus the usual of around six months.

Existing homes – the biggest component of supply – is constrained and the housing stock that is available is typically old, in need of repair and too expensive, said UBS housing analyst John Lovallo, in a 13 June video report prior to the latest US housing data.

Adding to the squeeze, rents have risen dramatically after the pandemic and continue to hover at high levels, although with some downward pressure lately.

Thus, the lack of existing available housing supply and high rents may be driving more people to the only viable alternative – buying a new home.

“The demand that’s out there, which has been reasonably good and better than feared, is all being channelled towards this group of public homebuilders which can also offer [better] financing terms because of their captive finance arms,” said Lovallo.

NEW HOMEBUYERS DRIVE MARKET
And these homebuilders are now ramping up construction to meet demand, particularly from first-time homebuyers.

“A key demographic factor is the younger millennials who are entering the prime home buying age of the early 30s. There’s a lot of them and this will provide tailwinds through the end of the decade. They need to live somewhere,” said Swift.

This will mean the new housing market shifting to lower, entry-level price points versus the “McMansions” of the past.

US homebuilder Lennar’s net average sales prices on home closings have dropped 10-11% from the peak of around $500,000 in 2022, to about $450,000 today with expectations that this lower level of pricing will remain constant through the year, said executive chairman Stuart Miller on the company’s fiscal Q2 earnings call on 15 June.

“There’s a void that needs to be filled. There’s a need and an appetite, and what we’re going to do is, instead of driving price, we are going to drive pace and hold price,” said Miller.

With mortgage rates flattening out, though still at high levels compared to recent history, prospective homebuyers also may just be getting more comfortable with the reality of higher borrowing costs for longer.

“I think the underlying fundamentals for homebuilding are still really good, despite some of these macro indicators that perhaps are sending a signal that is not quite as reflective of the underlying dynamics,” said Lovallo from UBS.

“Bottom line – supply is short, demand is returning to affordable offerings, and builders will need to produce more homes to fill the void,” said Miller from Lennar.

ONE DATA POINT DOESN’T MAKE A TREND
However, the stunning surge in US housing activity in the latest data may not be sustainable in the longer term.

“Even with the strong May activity, I suspect there will be some economic headwinds in the form of a slowdown in the economy and job gains,” said Swift from ICIS.

The ICIS senior economist sees US housing starts averaging 1.36m in 2023, down from 1.55m in 2022 and 1.60m in 2021. Assuming a mild or rolling recession, he forecasts housing starts falling to 1.31m in 2024 and then rebounding to 1.39m in 2025. The most recent consensus forecasts are for 1.33m in 2023 and 1.32m in 2024.

Insight article by Joseph Chang

Thumbnail shows the logo for the 1984 movie Ghostbusters. Source: Shutterstock