Homes: The Case Of M2V And The Elusive Recovery
"Chance has put in our way a most singular and whimsical problem, and its solution is its own reward." - Sherlock Holmes
Very much like Sherlock Holmes, analysts everywhere are analyzing each and every data point relating to housing hoping that it is "the" conclusive bit of evidence that proves the long awaited housing recovery has arrived. The recent spate of housing numbers, while improved over recent months, have bolstered those calls that the bottom is "in" and a "recovery" has begun. The mystery of the "elusive recovery" continues.
We have been very vocal that while we may have indeed seen the "bottom" the ensuing "recovery" may be a far more elusive. (See here, here and here) However, there are three major clues that will continue to retard recovery for quite some time - global drag, employment and the velocity of money.
Clue 1: Global Drag
It is entirely understandable why everyone wants housing to recover. From a homeowners standpoint, particularly the 1/3 Americans that are underwater in their mortgage, a recovery in housing gives them not only a psychological boost but also options from selling, mobility or simply refinancing to lower monthly payments. For economists, and analysts, a recovery in housing is needed to provide a boost to economic growth from the large multiplier effect of each dollar invested in the overall economy. However, residential investment today, as a percentage of GDP, is far less impactful than it has been in the past. Currently residential investment is near the lowest levels on record as a percentage of economic growth.
What is important, however, is the rise in the importance of exports as a percent of GDP. Exports have made up roughly 40% of the economic growth since the last recession. As the internet, Fed Ex, technology and telecommunications have developed the world has become a much smaller place. Since 1990 exports, as a percent of GDP, has more than doubled from 6% to over 13% today while housing has declined by more than half. With China and the Eurozone slowing, or in recession, it is unlikely that the domestic economy can remain decoupled for very long and those recessionary forces on the domestic economy will continue to depress any nascent housing recovery that may exist.
Clue 2: Employment
The second, and very powerful, case against a long lasting housing recovery at the current time - employment. When President Obama took office in January of 2009 the total number of nonfarm employees in the U.S. was 133,561k. As of the May report, the most recent at the time of this writing, actual employment has FALLEN by 552k individuals to 133,009k. Without a solid employment foundation it is impossible to have a lasting housing recovery particularly in today's credit constrained environment due to stricter lending requirements.
With the economy beginning to show signs of weakness in a majority of economic releases, and corporations struggling to meet much lowered earnings estimates and giving negative outlooks, employment may remain under duress for some time longer. The continued weak employment environment, which has resulted in a large and available labor pool, has kept wages and salaries depressed which further exacerbates the long term housing recovery hopes.
Clue 3: Velocity Of Money
Finally, there is one important piece of evidence that has eluded the many that are calling for an impending recovery - the velocity of money or M2V. The velocity of money (also called velocity of circulation) is the average frequency with which a unit of money is spent on new goods and services produced domestically in a specific period of time. In other words M2V is a measure of the amount of economic activity associated with a given money supply. However, changes in M2V do not show up at the consumer level immediately particularly when it comes to buying houses as it takes some time for the changes in velocity to work their way through the system.
The chart shows a composite index of new home permits, starts, completions and sales. These components are what I consider to be "economically important housing components" as they have the biggest impact to the economy. While existing home sales are certainly newsworthy - the relative impact to the economy from trading houses is very small. I have overlaid the composite index with M2V advanced 8-quarters. Not surprisingly you find a very close relationship between the increases and decreases in M2V and the housing index.
The most recent increase in M2V predicted the current bump in housing activity as of late as it filters through the system. What is important to note is the sharp decline that is currently underway in velocity. The deflationary forces that have gripped the global economy since the financial crisis began have been quelled by massive rounds of stimulative intervention both domestically and abroad. However, as those stimulative programs conclude, the deflationary forces regain traction slowing the global economy.
"These are much deeper waters than I had thought."
I do believe that it is very likely that we have found a bottom in housing. However, a bottom in housing and a recovery are two very different things. Recent upticks in housing data have had more to do with seasonal adjustments, skewing of data by turnover of the lowest priced homes, interest rates at the lowest levels on record and massive government programs to promote housing activity. Eventually, all of the abnormalities will be alleviated and we will be left with real organic growth which is likely far weaker than realized.
The recent sharp decline in M2V is working its way through the system which should be concerning for the housing bulls as housing as been more sensitive to declines in M2V than advances - particularly recently. What all of this illustrates is that it is likely far to early to be breaking out the party hats to celebrate the rebirth of housing. It is also very likely that the recent run up in home building stocks (XHB, IYR) and residential REITS (VNQ) have gotten ahead of themselves.
Am I saying that there is another "crash" in real estate coming? No, I am not. Will there be another decline in housing? Absolutely. There is no question that another decline will occur - it is only a question of when and to what level. That decline will become much more evident as the economy begans to slip towards the next recession, which without further QE from the Fed, could be sooner rather than later.