Facts & Trends: U.S. Housing A House Of Cards?


Not that long ago, housing seemed to be a hopeless basket case. Yet, the combination of limited supply with abysmal mortgage rates brought such a revival that housing is now considered the only reliable support of the U.S. economy. Apparently, housing is so affordable in the U.S. that even a doubling in mortgage rates would not derail the uptrend.

This recent note from BMO Capital echoes the current conventional wisdom:

Referring to the recent move up in rates, Chairman Bernanke said  Wednesday that “the change in mortgage rates that we’ve seen so far is not all that dramatic”. Note that prices got so depressed during the downturn that affordability is still miles better than pre-bubble norms. In fact, even if mortgage rates rise to 6% over the next 3 years (about 200 bps), and income grows a moderate 3.5% per year, home price growth can still run at 7% per year without stretching affordability. So, the positive spinoffs from housing (confidence, construction, consumer spending, etc.) should continue even as rates rise.


Why, then, didn’t we get a housing recovery much earlier? After all, mortgage rates have been well below 6% since 2010.

Partly because house prices were still falling, but also for many other mundane reasons, including weak income and tight credit conditions.

Click to View(Doug Short)

The truth is that nominal median income is not even back to its 2008 level and real median income remains 10% below its 2008 peak. Meanwhile, the median sales price for new houses jumped 23% during the last 12 months to an all-time high (!). Median existing house prices are up 10% YoY. Median prices can be influenced by many variables including a changing mix but these nonetheless reflect actual transactions, i.e. real demand.



Even though income has declined, historically low mortgage rates have increased mortgage affordability through reduced monthly payments. This was Bernanke’s bet and it is precisely why mortgage rates are so crucial, since housing affordability has actually not improved all that much. This chart from Zerohedge should be considered by house builders who have aggressively raised prices lately.

We are bombarded with national statistics but real estate is, in reality, a very local business. National averages are virtually meaningless in that industry. House prices, income levels and other economic and demographic factors are very different in San Francisco, Detroit and Houston. Demographia, a consultancy, rates national affordability by measuring individual metropolitan markets, a much more sensible and precise way to assess affordability. Its most recent analysis found that affordability of existing houses has actually not improved much in recent years.

From the Demographia International housing Survey:

The Demographia International Housing Affordability Survey employs the “Median Multiple” (median house price divided by gross before tax annual median household income) to rate housing affordability. The Median Multiple is widely used for evaluating urban markets, and has been recommended by the World Bank and the United Nations and is used by the Harvard University Joint Center on Housing.

Historically, the Median Multiple has been remarkably similar in Australia, Canada, Ireland, New Zealand, the United Kingdom and the United States, with median house prices having generally been from 2.0 to 3.0 times median household incomes (historical data has not been identified for Hong Kong), with 3.0 being the outer bound of affordability.

Based on Q3’12 data,

Overall, the US Median Multiple was 3.1 (moderately unaffordable), up slightly from 3.0 last year. The United States had 100 affordable markets, 87 moderately unaffordable markets, 13 seriously unaffordable markets and 16 severely unaffordable markets.

These details will help you understand the dynamics (my emphasis):

Housing affordability deteriorated in the 51 major markets of the United States from a Median Multiple of 3.1 to 3.2. This year, 20 major markets are rated as affordable, down from 24 last year.

Severely depressed Detroit remains the most affordable major US housing market, with a Median Multiple of 1.5. The second most affordable major market is Atlanta, with Median Multiple of 2.0. At the peak of the housing bubble, affordability deteriorated to a moderately unaffordable 3.1 in Atlanta. Atlanta had been among the high income world’s fastest-growing metropolitan areas for at least three decades, but slowed briefly during the Great Financial Crisis. Growth has returned, with Atlanta ranking third in net domestic migration among US metropolitan areas with more than 5 million population. (…)

As was the situation last year, six major markets are rated severely unaffordable. Four of these markets are in coastal California, where housing affordability deteriorated markedly over the past year, especially in San Francisco (7.8) and San Jose (7.9), where the Median Multiple rose by one point or more — the median price of houses rose the equivalent of a year’s median household income. The Median Multiple has now risen in both San Francisco and San Jose to 30% or more higher than at any point before the California housing bubble. The Median multiple also rose 0.5 points in Los Angeles.

Pointing up Affordability could continue to deteriorate as regional planning agencies implementing new state regulations under Senate Bill 375 that virtually outlaws new housing on the urban fringe. Even in the face of heavy net outward migration to other states, this could lead to a new housing bubble. (…)


The scores at the end of 2012:


While U.S. affordability is better than for the other markets measured, it remains high relative to its own history.


In brief, U.S. housing is not as extraordinarily affordable as some national statistics suggest. In fact, given that house prices have increased further since Demographia compiled the Q3’12 data, housing affordability has been getting worse in 2013.

This is why mortgage interest rates are so crucial.

This is like when we are considering buying a new car. We first determine what kind and size of car is affordable given our income level. Then we consider financing options to assess loan affordability. Even at zero interest rates, there is a limit on what we can afford, especially when we factor in other costs such as insurance, maintenance and repairs.

Coming back to the income side of the ledger, the Washington Post blog had an interesting post last February that helps explain the stagnation in median income: How the recession turned middle-class jobs into low-wage jobs

(… ) The vast majority of job losses during the recession were in middle-income occupations, and they’ve largely been replaced by low-wage jobs since 2010:

job losses gains

Mid-wage occupations, paying between $13.83 and $21.13 per hour, made up about 60 percent of the job losses during the recession. But those mid-wage jobs have made up just 27 percent of the jobs gained during the recovery.

By contrast, low-wage occupations paying less than $13.83 per hour have utterly dominated the recovery, with 58 percent of the job gains since 2010.

That’s put downward pressure on wages: “[M]any middle-class workers have lost their jobs and, if they have been able to secure new employment at all, find themselves earning far lower wages post-recession,” the San Francisco Fed notes. ”[O]n average over the next 25 years, these workers will earn 11% less than similar workers who retained their jobs through the recession.”

That means that nearly 2 million of the 6.2 million re-employed workers since the spring of 2010 earn substantially less than before the recession. This is 2 million families that moved from the approximate median income level to a low income level, dragging the median down in the process. No doubt that their sensitivity to both house prices and mortgage interest rates has increased significantly.

The Royal Bank of Scotland adds in a more recent report that

Another concern raised about the “type of jobs” being created concerns the elevated number of part-time workers. The percentage of workers who are working part-time is indeed higher now than it was prior to the recession – 18.6% of total non-agricultural employment in April 2013 versus 16.5% in December 2007. However, this is down from its recessionary peak of 19.9%.

That’s nearly 1 million new part time workers also further away from affordable housing.

Taking into account the number of people with lower paying jobs, with new part time jobs, those who moved out of the labor force, those who joined the food stamps or other such social security programs, etc. the economic reality of the median American has worsened very significantly in recent years.

Remember that 50% of Americans reside below this lower median! Rising median house prices may look positive to economists and strategists who generally live well above the median, but not to the folks below and even those 10-20% above it. Income inequality has some downside!

This chart from Doug Short clearly illustrates the significant, enduring, downshift in retail sales since the financial crisis, a direct result of the significant, enduring, downshift in income. By Doug’s calculations, retail sales are 18% below their pre-2008 trendline. Really nothing to write home about!


As a matter of fact, first-time buyers accounted for only 28% of purchases in May, down from 34% one year ago and well below the historical norm of 40%. This is not a sign of a healthy market.

Let’s not lose sight of the fact that 30-35% of the houses purchased in recent years have been bought by investors. This one third of the demand, which will eventually become one third of the supply, potentially even more, is highly sensitive to house prices and to interest rates. One, professional investors buy with set return objectives which are highly sensitive to cost and the cost of carry. Two, they must have an exit strategy that takes into account the eventual end buyers’ ability to buy and finance, as well as their assessment of when other investors will begin unloading. It is often much easier to invest than to disinvest.

Raymond James & Associates housing market analyst writes that investor interest in the very popular (read depressed) Phoenix market seems to be waning:

According to Arizona State University, identified investors purchased 27% of all homes in April, the lowest percentage in several years and down from 35% a year ago. Home purchases financed with cash comprised 39% of all sales in May (down from 42% in April and 46% a year ago). Notably, according to ASU, the institutional buying spree peaked in the summer of 2012 and has now subsided. In total institutional investors now own 10,000-11,000 homes (or ~1% of the housing stock) in Greater Phoenix.

Now, 1% of the housing stock may not seem high, until you realize that 10-11k homes is, in fact, equal to half the current listings in Phoenix. The exit door can get pretty narrow…

The RJ analyst also notes that even though Phoenix existing home sales rose 12% YoY in May, pending sales declined 14% YoY after being down 8% in April. Interestingly, his comments on the Phoenix rental market, where most of the institutional stock is parked, are also not very positive:

Very importantly, though, we believe a large percentage of these newly acquired rental homes are being “warehoused” off-market until rehab
work can be completed (or other vacancies are leased up). Anecdotally, we found that a quick search on craigslist.org screening Phoenix
homes for rent with 3+ bedrooms turned up more than 4,000 links posted in just the past 24 hours (June 18-19).

There is thus a real possibility that housing demand stops rising pretty soon unless basic fundamentals improve meaningfully. Once again, the tendency of investors and economists to simplistically straight line recent trends will likely prove wrong.

Rising interest rates will also cool investors’ appetite for exotic yield plays, many of which have been artificially stimulating housing demand recently. I feel compelled to reprint an excerpt of my Feb. 25, 2013 post Housing Stocks: Buy Low, Sell High because it is so illuminating!

(…) “They didn’t ask us to fix anything, either,” said Creswell, 35, a pastor at a Wake Forest church who has flipped six houses since the market crashed in 2008. “They just bought it. It was the easiest housing closing I’ve ever been a part of. … They were a dream buyer.”

The dream buyer is American Homes 4 Rent, a Malibu, Calif., company that since late December has paid nearly $13.3 million in cash for 81 houses in Wake County, according to property records. The company, which formed last year, is one of several firms hoping to profit from rising home prices by amassing thousands of single-family homes across the country and converting them into rentals. (…)

What’s noteworthy about American Homes 4 Rent’s buying binge in Wake County is that it isn’t just targeting distressed properties, or even existing homes. About a third of its purchases have been new homes acquired directly from homebuilders.

“Very reasonable offers, they’re not trying to low-ball us,” said Dan Cunningham, of Brandywine Homes, which sold a house in the Braemar subdivision in Zebulon to American Homes 4 Rent for $152,000. “I mean,I don’t understand why they’re buying new homes to rent, but that’s their business model, I guess.” (…)

Institutional investors have invested at least $5.4 billion for purchase of single-family rentals nationwide during the past 18 months, according to Barclays, and an additional $8 billion is expected to be invested within the next couple of years. American Homes 4 Rent’s buying spree is being financed in part by a $600 million investment from the Alaska Permanent Fund, a $45 billion fund that invests royalties the state collects from oil companies. (…)

“Usually an investor will come in just at some ridiculous number you can’t deal with,” said Jeff Murdock of Murdock & Gannon Construction, which sold three new homes to American Homes 4 Rent in the Carlton Park subdivision in northeast Raleigh. “But these guys weren’t that way, bless their hearts.”

Bless their hearts! I would not bet much on whether much of the “additional $8 billion” will eventually be invested, at least wisely…

What about supply?

Believe it or not, supply has been increasing along with prices. Redfin, an online realtor, wrote on June 17 that

Inventory is finally beginning to recover! Active listings grew 6.4% between March and April and another 4.2% on top of that between April and May. Last year inventory peaked in January and fell almost all year. If the current trend keeps up, we may hit positive year-over-year inventory before the end of the year.

The growth in new listings has also been explosive over the same period. New listings have turned around completely in just four months, from a 10% year-over-year decline in January to a 15% year-over-year increase in May.

Redfin CEO Glenn Kelman:

People who bought near the peak in 2006 and 2007 — only to get buried in the downturn under a mountain of debt — can now, for the first time in years, see daylight. And they’re running for it.


This is obviously good news, especially for realtors and buyers. More listings may result in more transactions. It should also have an impact on prices which might surprise some people:


Note that only 2% of respondents expected prices to rise a lot in early 2012!

The big unknown is how professional investors will react to stalling price momentum and rising supply. It would be challenging to replace 30% of the demand on short notice.

The number of Redfin customers touring homes and making offers both dipped a bit more in May this year than over the same period last year, pointing toward a slight softening of sales volumes in June and July. This despite the fact that inventory improved in April, and will have improved again in May. Months of bidding wars and record-low inventory earlier this year has finally taken a toll on some buyers. Rising interest rates are likely discouraging some buyers as well. (Redfin)

While 23% of respondents are currently bullish on prices, 67% believe that now is a good time to sell in their neighborhood, up from 13% in Q1’12:


And here’s the wrap-up chart, one that Bernanke and friends should study carefully:


Low prices are no longer a major incentive. Positive price momentum has moved the fence sitters but this may be about to stop. The one major remaining incentive is low interest rates.

This is why mortgage rates do matter.

This is why the Fed is playing with fire trying to be “good at communications”. Bernanke may say that the FOMC has no intention of raising interest rates anytime soon, how can he forget that the only reason mortgage rates are so low is QE3? He, himself, closed the debate between flows and stocks, thankfully winning his bet. He is now risking losing it all playing Russian roulette. He may be better at communications but he is still an amateur on investor psychology.

Bernanke may say that all he will do is gradually take his foot off the gas pedal, the market knows too well that he is Driving Blind. Just consider that the May FOMC statement said that the panel “continued to see downside risks to the economic outlook.” One month later, it declared that “downside risks to the outlook for the economy and the labor market have diminished since the fall”.

No wonder some people now suspect that Bernanke is actually DUI. After all the “financial heroin” (h/t Don Coxe) he has injected in the economy…

Let’s be clear, housing is in a cyclical recovery, supported by rising household formations and relatively limited supply. But contrary to what many believe, its fundamentals remain very fragile, the road ain’t gone be straight up and policy mistakes are precisely what can totally derail it.


Facts & Trends: Housing Stocks: Buy Low, Sell High


The Great American Housing Rebound<br />
Illustration by Andres GuzmanOn Jan. 3, 2012, I suggested that U.S. housing market fundamentals had turned positive, that house prices had bottomed and that housing would soon become a positive contributor to the economy, employment growth, retail sales and bank balance sheets.

As Don Coxe would say, the housing recovery story has clearly moved from page 16 to front page one year later as this weeks BW cover illustrates.

Several signs are now suggesting that investors should carefully review their positions in housing-related stocks.

Not that the fundamental story has changed for the worse. Demand is gradually strengthening but the real trigger is tight supply, pushing prices higher. Rising house prices often tend to be self-feeding, especially when affordability and pent-up demand are high like today.

Supply is clearly extremely tight just when we are entering the seasonally strong spring period: new and existing housing inventory is exceptionally low, distressed house supply remains constrained, delinquencies are falling rapidly and will fall even faster as prices rise and builders are only slowly ramping up new home construction.imageCalculatedRisk

However, markets being what they are, valuations of many housing-related sectors have risen to such levels that the risk/reward balance has totally turned upside down in a little more than one year.

First evidence: lumber prices are back to their 2005 levels and clearly at the high end of their cyclical range.

Yet, housing starts are still at the bottom of their historical range.

FRED Graph

Low lumber supply and excess liquidity often result in such aberrations. Lumber production always collapses along with prices. It also always recovers along with prices. Spring is just about there, so expect much busier North American lumber mills in coming months.

Meanwhile, high lumber prices will undoubtedly erode builders’ margins.


“Buy low” was 12-18 months ago. No longer. Homebuilder stocks are not near their 2005 peak but why would they go back to that bubbly era?

Bespoke Investment

I present three Morningstar/CPMS charts since 1990 on homebuilders price/book (red) and ROE. How lucky do you feel?

KB Home




Toll Brothers


Looks like “sell high” to me.

How about all the funds buying distressed houses to rent them? Pretty soon, renters will prefer to buy and the funds will seek to sell out. More supply.

imageJ.P Morgan

Here’s what one of these funds is doing in North Carolina (California billionaire bets on rentals with Wake home-buying spree via CalculatedRisk)::

(…) “They didn’t ask us to fix anything, either,” said Creswell, 35, a pastor at a Wake Forest church who has flipped six houses since the market crashed in 2008. “They just bought it. It was the easiest housing closing I’ve ever been a part of. … They were a dream buyer.”

The dream buyer is American Homes 4 Rent, a Malibu, Calif., company that since late December has paid nearly $13.3 million in cash for 81 houses in Wake County, according to property records. The company, which formed last year, is one of several firms hoping to profit from rising home prices by amassing thousands of single-family homes across the country and converting them into rentals. (…)

What’s noteworthy about American Homes 4 Rent’s buying binge in Wake County is that it isn’t just targeting distressed properties, or even existing homes. About a third of its purchases have been new homes acquired directly from homebuilders.

“Very reasonable offers, they’re not trying to low-ball us,” said Dan Cunningham, of Brandywine Homes, which sold a house in the Braemar subdivision in Zebulon to American Homes 4 Rent for $152,000. “I mean, I don’t understand why they’re buying new homes to rent, but that’s their business model, I guess.” (…)

Institutional investors have invested at least $5.4 billion for purchase of single-family rentals nationwide during the past 18 months, according to Barclays, and an additional $8 billion is expected to be invested within the next couple of years. American Homes 4 Rent’s buying spree is being financed in part by a $600 million investment from the Alaska Permanent Fund, a $45 billion fund that invests royalties the state collects from oil companies. (…)

“Usually an investor will come in just at some ridiculous number you can’t deal with,” said Jeff Murdock of Murdock & Gannon Construction, which sold three new homes to American Homes 4 Rent in the Carlton Park subdivision in northeast Raleigh. “But these guys weren’t that way, bless their hearts.”

Sounds like too much money seeking a home. If I were an officer of the Alaska Fund, I’d be worried.

Want to own REITs or timber stocks? Good idea! A bit late, however:

imageJ.P Morgan

How about hardware stores? No pure plays and no great bargains but they sure look less risky to me. At least, their ROE’s are pretty good.

Home Depot




Banks are even less risky, if they can restore their ROEs…Higher house prices and a positive yield curve would obviously help.

Wells Fargo


J.P. Morgan


Bank of America





FACTS & TRENDS: The Coming Income Cliff

In April 2012, I wrote The U.S. Consumer About to Retrench concluding that the American consumer could simply not continue supporting the U.S. economy given the clearly weak trends in employment and wages and steady inflation. My subsequent updates acknowledged the surprising strength in personal income but warned of the income cliff coming in early 2013 even assuming a favorable resolution of the fiscal cliff negotiations.

Last Friday’s release of the October Personal Income and Outlays data included significant revisions to the April-September data which confirm that Americans are no longer supporting the economy and that the impending income cliff is indeed right before us.

Personal consumption expenditures decreased 0.2% M/M in nominal dollars in October. That followed strong gains in the July-September quarter totaling +5.7% annualized, even though disposable income rose only 2.4% annualized.

When inflation is factored in, consumer spending fell 0.3% in October after rising at a 2.8% annual rate in Q3.

The Commerce Department partly blamed Hurricane Sandy for the weaker October stats:

The October estimates of personal income and outlays reflect the effects of Hurricane Sandy, which made landfall in the United States on October 29. The storm affected 24 states, with particularly severe damage in New York and New Jersey. BEA cannot quantify the total impact of the storm on personal income and outlays because most of the source data used to estimate these components reflect the effects of the storm and cannot be separately identified. However, BEA did make adjustments where source data were not yet available or did not reflect the effects of Sandy. The largest of these adjustments was for work interruptions, which reduced wages and salaries by about $18 billion (at an annual rate).

Most pundits used this to bury their head in the sand and simply blame the weather for the poor data.

What many missed is that the revisions to the previous 6 months data are confirming the dire state of the American consumer and the looming income cliff which, unless consumers meaningfully dip into their savings, will hurt the economy during the next 6-12 months.

Lance Roberts had an excellent piece on the revisions:

(…) the Hurricane excuse doesn’t account for the negative revisions to the personal income data going back to April of this year.  The chart below shows the level of personal incomes both pre- and post revisions in October. 


The effect of the revisions is that personal income was shaved by $50B, or 0.4%. September Personal Income growth has thus been ratcheted down from a surprising +3.9% Y/Y to +3.5%. In total, PI grew only 1.0% between March and September 2012, a slow 2.0% annual rate. That is a huge revision from the original 1.5% gain (3.0% annualized). Add the zero M/M growth in October and the Y/Y increase falls to 3.1%. These numbers are all in nominal terms. Since inflation is an unrevised 1.7%, real Personal Income growth is less than 1.3% and real Disposable Income growth is 1.2% Y/Y. Roberts goes on:

Moving on to personal spending it is not surprising that the previous estimates to spending were likewise revised down in October to reflect weaker income growth.  The chart below shows the revision to the major categories of spending for the months of July, August and September.


Since April 2011, Americans have been growing their spending faster than their income, helping sustain a weakening economy. This has come to a halt in the last 2 months.


Here’s another way to look at the recent trend:


The chart above shows that Americans have stopped outspending their income. Not apparent, yet, is that PDI growth is about to slow markedly from 3.0% to 1.5-1.7% Y/Y. Extrapolating the M/M growth of the last 6 months, disposable income growth will fall off a cliff next January and real income growth will drop from the 1.2% range to zero as early as February or March, not even factoring in anything from the fiscal cliff negotiations.


Can a lower savings rate save us again? That would be an heroic assumption since the savings rate is already at 3%, a level rarely broken during the last decade. The 2005-2007 low savings rate was due to the excessive borrowing that led to the housing bust, a scenario unlikely to find a sequel anytime soon.


Assuming expenditures grow roughly in line with income in coming months, nominal spending growth will drop to the 2.0% range early in 2013. If inflation remains around its current 1.7%, real expenditures will flirt with zero growth within a few months.


What the economy quickly needs is:

  • a sharp acceleration in employment growth;
  • slower inflation, particularly lower oil prices;
  • a quick and favorable resolution of the fiscal cliff.

Otherwise, we all fall into a cliff, be it a fiscal, income or equity cliff. Equity markets are inexpensive, but for good reasons.


Facts & Trends: The U.S. Energy Game Changer


The most dramatic change to the global oil map is the boom in the United States, with the “light, tight oil” that is now being produced in North Dakota’s Bakken field and Texas’ Permian and Eagle Ford plays. The IEA forecasts that the U.S. will increase its production by 3.3 million barrels per day over the next five years to 11.4 million barrels, a level that exceeds the current output of Saudi Arabia. (Charting the future of crude oil)

There is admittedly a controversy on many aspects of this “revolution”. Doubters claim that projections take little account of declining production at many mature fields and the expected high decline rates in shale wells. Political and environmental issues also add to the hurdles.

Nonetheless, the proof is in the pudding and the fact is that U.S. oil production is actually growing fast, and faster than previously forecast. image_thumb[18]

U.S. crude oil and natural gas liquids (NGL) production rose by 0.6 Mb/d during the 24 months between Q1/09 and Q1/11 and by 1.0 Mb/d in the following 12 months. This sharp acceleration is coming mainly from the shale formations. Here’s a telling chart from RBC Capital:


When shale gas exploration began to accelerate in 2007-08, there were also many doubts about its sustainability and eventual size. These doubts proved unfounded. We could well be living the same phenomenon with shale oil.

The North American energy picture is improving very rapidly and very significantly.

  • The U.S. oil and NGL production looks set to jump 40% during the next 5 years.
  • The Canadian production could increase 31%.
  • Combined, this 4.4 Mb/d incrementalproduction is nearly 5% of total world production and nearly 14% of OPEC output.
  • This is happening right when the U.S. and world demand is weakening. In this context, can OPEC maintain current high prices for very long?

Imports accounted for 50% of U.S. oil and liquids consumption in 2010. The EIA forecast was for imports to decline to about 40% by 2017 but it now looks like it will be closer to 35%. By itself, this will have a huge impact on the U.S. trade balance.

Consider also the impact of booming natural gas production: the U.S. is expected to be a net exporter of gas in 2022. It imported 4 trillion cubic feet in 2008, 2.6 Tcf in 2010!

In all, in just a few years, the U.S. energy situation has shifted very significantly. A real game changer if there is one!

A December 2011 PwC report concluded that

(…) high shale gas recovery and low prices could impact United States manufacturing industries by adding one million workers, and reduce natural gas expenses by as much as $11.6 billion annually through 2025.

“An underappreciated part of the shale gas story is the substantial cost benefits that could become available to manufacturers based upon estimates of future natural gas prices as more shale gas is recovered,” said Bob McCutcheon, U.S. industrial products leader, PwC. He continued, “In fact, the number of U.S. chemicals, metals and industrial manufacturing companies that disclosed shale gas potential and its impact so far in 2011 easily surpassed that of the last three years combined, indicating this is of growing importance in the outlook of U.S. manufacturers. The significant uptick in shale gas commentary among the manufacturing community reflects the positive influence that shale gas is having from investment, operational and demand standpoints.”

In a March 2012 report, Citigroup, perhaps in typical brokerage fashion, made even rosier forecasts incorporating the indirect impact that the shale oil and gas revolution will have on the economy:

We estimate that the cumulative impact of new production, reduced consumption, and associated activity could increase real GDP by an additional 2% to 3%, creating from 2.7 million to as high as 3.6 million net new jobs by 2020. Furthermore, the current account deficit could shrink by 2.4% of GDP, a 60% reduction in the current deficit, by 2020. This could also cause the dollar to appreciate in real terms by +1.6 to +5.4% by 2020.

Citigroup rooted the recent trends to higher capex:

Starting in 2009 (more than five years following the global surge in upstream capex), new discoveries — excluding extensions and revisions to
existing fields — started to surge, with 2010 being the first year in a quarter of a century when oil discoveries (taking into account NGLs and other liquids, refinery processing gains and biofuels) were greater than oil consumed. Initial data for 2011 is pointing in the same direction.

And so are the 2012 data which, in fact, are showing an acceleration in shale oil output.

imageThe radical change in the U.S. natural gas market has been well documented.  America’s abundant supply of natural gas is extremely cheap relative to international prices which are regulated and linked to the price of oil. The current high prices for oil and natural gas internationally give America a significant competitive advantage thanks to its domestically traded, deregulated market.

Pimco details the benefits:

But the most momentous change of all looks likely to be in the re-industrialization of America based on dramatically lower cost feedstock than is available anywhere in the world, with the possible exception of Qatar.

Industrial processes are being retooled to use natural gas, instead of oil derivatives, due to gas’s cost advantage. It is this cost advantage in fuel and feedstock supply in North America that is partly contributing to the revival and expansion of the industrial sector.

imageFor industries with large physical plants, such as metals, machinery and  much of the manufacturing sector, natural gas consumption typically exceeds 30% and in some cases 50% of their respective total energy demand. Over the long run, the abundance of natural gas and the just-in-time production would reduce price volatility and place a long-term cap on prices. Fuel substitution, especially with coal and petroleum, and a reduction in the per unit expenditure on gas would lower the overall cost of operation and improve competitiveness.

The agricultural sector would be another beneficiary of the natural gas boom due to its use of fertilizers. Natural gas accounts for the majority of the cost of producing ammonia fertilizer, where gas is used to make ammonia. Higher gas production and lower prices have contributed to the return of activities. Orascom Construction bought and reopened a large ammonia plant in Beaumont, TX. CF Industries also restarted its large Donaldsonville, LA plant and has planned over $1 billion in investments to expand ammonia production capacity over the next four years. Saskatchewan’s Potash Corp is investing in the restart of an ammonia plant shut in 2003.

US ethane-based ethylene producers have moved to the lower end of the global cost curve, after only the Middle East and Canada, and are currently enjoying record margins. By comparison, naphtha-based ethylene producers in Europe and Asia are at a competitive disadvantage.

Cheaper natural gas has also made US methanol production more economical. Consequently, Canadian methanol producer Methanex recently announced plans to relocate an existing methanol plant from Chile to the US Gulf Coast in 2014. Next year Lyondell Basell plans to restart a methanol plant on the Gulf Coast that was idled in 2003 because of high natural gas prices.

Natural gas is an industrial commodity, used by large producers in plants requiring long lead times between planning and actual operations. This is why the real impact of lower natural gas prices on U.S. industrial activity is only beginning to surface.

This chart from RBC Capital illustrates how the U.S. competitive advantage on natural gas will shortly result in a booming ethylene industry. Given the long lead times required, momentum builds slowly but eventually the planned projects emerge. In a matter of 7 years, U.S. ethane production could expand by 50-80%.


However, the U.S. economy relies far more on oil than natural gas as a percentage of overall energy consumption. The more recent changes in the U.S. oil production profile will therefore have a more significant and immediate impact on America’s industrial and manufacturing sectors.

For starters, even though the U.S. will continue to import oil, its large and increasing domestic supply will no doubt make the U.S. more attractive for international industrial and manufacturing companies. Secondly, U.S. domestic oil prices are currently 20% cheaper than Brent and this spread could widen even more if the U.S. landlocked production grows significantly faster than pipeline capacity. For security reasons, exports of crude oil are not permitted in the U.S. Without the ability to export, U.S. crude oil could become as disconnected from world markets as U.S. natural gas is. On the other hand, a meaningful push to expand pipeline capacity could help narrow the spreads.

Most of U.S. shale oil production is reportedly profitable at a price of oil ranging from $60 to $70 per barrel, thus making the industry sufficiently resilient to a significant downturn of oil prices.

Energy cost and secure availability are cornerstones of all dynamic economies. The U.S. now finds itself in a most advantageous position, enjoying among the lowest energy costs in the world with secure and ample supplies in a most stable geopolitical environment.

The economic dividends of such competitive advantage are very meaningful and long lasting. They tend to build up slowly before they become visible to everybody and add up to a significant economic stimulus. Their impact has already begun but most of it has been masked by the lingering economic and financial crisis.

For example, employment in the oil and gas extraction sector has improved in recent years but it has the potential to substantially exceed its 1982 peak.


Employment in oil and gas support activities, a prime beneficiary of the shale gas boom, has grown nicely since 2010 but it has yet to feel the impact of the more recent shale oil boom.


Together, these two sectors now employ some 470,000 people when they barely employed 245,000 people back in 2004, well before the financial crisis. IHS Global Insight predicts that direct, indirect and induced employment in shale gas onlyis estimated to grow to 869,684 employees in 2015 from 601,348 employees in 2010.

The U.S. manufacturing sector is enjoying a renaissance on its own but energy will provide additional momentum in coming years. The Boston Consulting Group’s 2011 report Made in America, Again, Why Manufacturing Will Return to the U.S listed a number of reasons for America’s improved competitiveness (e.g. relative wages, productivity, transportation logistics) but made little mention of the energy cost gap developing between the U.S. and its main competitors in the world.

In a more recent analysis, PwC makes energy a more explicit and significant reason for “reshoring”.

The United States manufacturing sector is experiencing a cyclical recovery. However, structural—and likely sustained— changes in some of these areas could extend the recovery beyond what might be expected in a typical economic upturn. Even if an increase in the relative competitiveness of United States labor costs were to unfold, that seems unlikely to be sufficient to result, in itself, in a domestic manufacturing resurgence.

Instead, a host of other factors— particularly transportation and energy costs, and currency fluctuations—are more likely the most salient reason United States manufacturers will choose to produce closer to their major customer bases.


Manufacturing employment has been relatively strong since 2010 amid a very difficult economy. Yet, its nearly 500,000 new jobs are but a fraction of the more than 5 million jobs lost since 2001.


Here are a few examples of this new “reshoring” trend:

  • “We’ve been able to reshore about 15 to 20 percent of our volume back to the U.S. from China over the last year,” said Bill Lovell, OtterBox’s global director of supply chain.
  • General Electric opened a $38 million manufacturing plant in Louisville, Ky., and said it plans to invest $1 billion in its appliances businessand create 1,300 American jobs by 2014.
  • Chinese electronics giant Lenovo, which acquired IBM’s personal- computer division in 2005, announced this month that it plans to open its first PC plant in the U.S. in North Carolina early next year, a move that will add 115 manufacturing jobs.
  • Colorado Flexible Heaters, an independent maker of heaters for roofs, moved the production of its systems from China to Glenwood Springs last year. The company opened a local manufacturing plant in May 2011 and found that it could make the heaters about 25 percent cheaper, said founder Dave McKenna.
  • When Sleek Audio got off the ground in 2005, they first found that U.S. manufacturers were quoting prices of $19 or $20 for one particular component that the Chinese were offering to make for $2. But when the Krywkos decided to quit China last year and asked around again about making the part in the U.S., this time the answer was $8. A box that used to be quoted for $4 to $5 in the U.S. before was quoted at $3 now.
  • “We just kind of got kicked right in the teeth dealing with China. It wasn’t any fun by any means. But it helped us learn to bring stuff back to the United States,” said Calibur11 owner Coy Christmas. The company, which makes cases for consoles such as the Xbox 360, will add a few employees in Duluth and more in Chicago, where it plans to hire contractors to handle molding, assembling and packaging.
  • “We found a Wisconsin company to make the blades. And without the shipping, testing and reject costs, they actually beat the price in China,” said Darlene Miller, owner of Permac Industries, a high-precision machine shop.
  • 3M Co. said it consolidated production of its Littmann stethoscope from 14 domestic and foreign contractors to just one factory in Columbia, Mo., a move that will improve efficiency.
  • Charles Bunch, chairman and CEO of PPG Industries, told CNBC’s Jim Cramer that the cost of energy within China also is much higher. “The China cost advantage in many energy-intensive industries is diminishing,” he told Cramer. “Now, the U.S. is going to be  much more competitive on the global scene in terms of manufacturing costs.”

Beyond these few real world examples of both small and large companies reshoring (or “onshoring”), a sea wave of change seems to be making its way toward American shores. The NY Post:

According to a survey by the Boston Consulting Group of executives at 106 manufacturing companies with $1 billion or more in sales, 37 percent said they are planning or “actively considering” onshoring. Among large firms with $10 billion in sales or better, almost half (48 percent) say they’re planning to move, or already have moved, their production facilities back to the States.

They include Master Lock, which recently returned to its original home base in Milwaukee, and NCR, which set up its ATM manufacturing division in Georgia. Appliance Park in Louisville is filling up again, as GE moves manufacturing divisions back home from China. Michelin is breaking ground on a new tire plant in South Carolina; Volkswagen has new facilities in Chatanooga, Tenn., and Airbus is building a $600 million plant in Mobile, Ala. Samsung plans to invest more than $20 billion in various US manufacturing enterprises.

Bob McCutcheon, PwC’s U.S. Industrial Products leader says that

Beyond the cyclical rebound, however, a host of structural changes is emerging that may lead to the U.S. becoming an important location for basing production and R&D facilities for several industries.  In addition to trends in labor costs, other factors include the need to reduce transportation and energy costs; the emergence of the U.S. as a more attractive exporter and the relative attractiveness of the U.S. markets.

The U.S. is obviously going through a soft economic patch due to ongoing weakness around the world. In spite of this and of its own home-made challenges, the U.S. economy has been surprisingly resilient, mainly because of a relatively vibrant export sector. Given the present state of most of America’s trading partners, the resiliency of American exports is noteworthy. Obviously, much is happening below the surface.

Amid all the doom and gloom, both at home and abroad, the U.S. is getting ready to take full advantage of its growing competitiveness. Citigroup’s conclusion may seem preposterous at this time but it reflects the potential rewards that energy portends:

At this point, it may be useful to step back and consider the sheer scale of the potential economic consequences in perspective: We are contemplating hundreds of billions of dollars of new output, three or four million new jobs, a current account deficit slashed by half or more, and a strengthened dollar firmly reasserted as the reserve currency of choice.

Not to mention the potential strengthening of U.S. federal and state government finances, the national security implications of improved energy independence, a resurgence of the nation’s technological and
manufacturing competitiveness, the social implications of new wealth and job creation, and many other silver linings.

Investors should therefore not let themselves sink into extreme pessimism. Hopefully, politicians will dig very deep within their selves and avoid impeding the emerging American industrial renaissance.

Equity markets are very cheap for many valid reasons (see P/Es, QEs & SAUDIS). The world is a mess with little visibility for a turnaround mainly because normal market forces are ineffectual, being relentlessly overruled by political and/or technocratic interventions. The hope for the world is that central bankers’ bets succeed and growth reappears without higher inflation.

Investors should nevertheless realize that the U.S. is staging a stealth recovery lead by energy, manufacturing and housing. So far, it has been masked by still weak employment growth and other mainly foreign problems as well as by the inability of politicians to effectively address the looming American fiscal cliff.

Yet, barring endless and fruitless political bickering, the American economy could soon surprise almost everybody and display strong and sustained growth in capital investments, construction and employment, irrespectively and independently of what might then be going on in Europe or in China. That would no doubt help narrow the current deep undervaluation in U.S. equity markets.



FACTS & TRENDS: The U.S. Consumer About to Retrench

With Europe and China as weak as they are, the U.S. manufacturing sector is unlikely to be able to maintain its strong upswing much longer. For his part, the U.S. consumer has been dipping into his savings since mid-2010, enabling him to satisfy some pent up demand and grow consumption by more than 4% YoY throughout the last 2 years in spite of dwindling growth in his disposable income.


The U.S. consumer has often in the past grown his expenditures faster than his income but never for a sustained period. It has now been 10 months during which his savings rate has dropped from 5.0% to 3.7%, contributing $150B or 34% to the $436B in increased spending during the last 12 months.


The savings rate is now at its lowest level since 2008. It reached lower levels during the peak of the housing bubble but it is doubtful that Americans will let reckless debt buildup happen again for another one or two generations. It surely would be very adventurous to expect the savings rate to average much less than 3.5% over the next year at least, along what was observed between 2000 and 2005.


Keeping the admittedly volatile savings rate constant, PDI will evolve along with the changes in employment, wages and tax rates.

U.S. employment growth has accelerated to 245k per month since December 2011. It had averaged 89k per month since 1990 but the yearly average reached 200k only once (2005) since 2000. During its best period of 1993 to 1999, monthly employment gains averaged 251k.

image image

However, it is important to note that up until 2008, government employment was almost invariably positive, averaging 20k per month between 1990 and 2008. Only in recent years have we seen substantial job losses at the various government levels, a trend likely to continue for a while.

imagePrivate employment growth has not exceeded 200k per month since 1999 and even during the boom internet years of 1993-99, private employment averaged 232k per month. Its recent 250k monthly average of the last 3 months is therefore unlikely to be sustained, even more so in the current economic environment. It is much more reasonable to expect private employment growth averaging 150k per month during the next 12 month period which, coupled with an average 5k monthly loss for government jobs would result in total employment growth averaging 145k per month from now on in 2012.

If that proves right, employment growth will cruise at a rate of 1.5% YoY for the rest of 2012. The upside if employment growth averages 200k is 2.0% YoY.

Wage gains, as measured by average hourly earnings, have been steady at 0.1% MoM for 7 months now. The YoY growth rate was 1.9% in February but if the recent monthly trend holds, the YoY growth rate will gradually decline towards 1.2% by year-end.

If we assume wage gains in the 1.5% range, employment income should thus grow in the 3% range with upside to 3.5%. This would be a significant slowdown from the 5% YoY growth rate of the last 5 months. But the slowdown is already occurring as wages and salaries have only increased 1.0% in total since October, exactly at a 3% annual rate.

There is no more help coming from government transfers. Quite the opposite, personal taxes are on the upswing as more people work and more states raise tax rates. The average personal tax rate has slowly climbed back from its 2010 lows. It was 11.1% in February, up from 10.8% last September when employment started to pick up. Needless to say, tax rates will likely act as a break to PDI growth from now on, even more so after the elections…


In all, nominal PDI growth slumped to 2.6% YoY in February, a little noticed but nevertheless significant slowdown from the 3.7% average growth rate of the previous 12 months. The U.S. economy was spared by the huge drop in the savings rate, a phenomenon unlikely to continue. Since PDI growth is likely to be contained within 2.5% and 3.0% during the rest of the year, spending growth can only slowdown even more from its 4.6% pace of the last 12 months.

The PCE price index was +2.3% YoY in February, down from a recent peak of +2.9% last September. Nonetheless, real PDI rose a meager 0.3% YoY in February compared with a still low 0.7% average monthly gain since July 2011.

While nominal PDI growth is slowing, the PCE deflator is accelerating: it rose 0.3% MoM in February and is up 0.6% (+2.4% a.r.) in the last 3 months, primarily due to rising energy prices. With nominal PDI growth limited to 2.5-3.0%, it goes without saying that if inflation stays in the 2.5% range, real income growth will simply stall.

The impact of rising oil prices, mitigated in recent months by the very warm winter, will become more damaging on discretionary income as 2012 progresses unless oil prices decline as much as they did last spring and summer. Gas prices averaged $3.65/g between June and September 2011 before plunging to $3.25 by year-end, just in time to free some discretionary income for Christmas. Can we be as lucky this year?


Can another SPR release provide enough relief? In June/July 2011, the IEA released 30mmb of oil to offset the loss of Libyan production during the Arab Spring. Oil prices initially declined some 5% but recouped it all within a week as markets worried about actual spare capacity. It took the Eurozone crisis to bring oil prices down meaningfully in August and September.

Looking further out, the U.S. fiscal cliff is approaching pretty rapidly and, unless Congress again kicks the (heavier) can further out, a slew of measures will shortly hit the economy (expiration of the Bush tax cuts, ending of the payroll tax cut, declining unemployment benefits and “automatic” $1.5T budget cuts).

The U.S. fiscal cliff is such that it should be seriously taken care of early in the first year of the next presidential mandate with the inevitable fiscal drag hitting the economy. However, the significant ideological divisions between Democrats and Republicans and the likelihood that neither party will secure 60 votes in the Senate mean that the gridlock will likely need to be broken, painfully for everybody including financial markets, by the bond vigilantes. Consumers and businesspeople will no doubt remain cautious as a result.

Martin Feldstein summarized the threat in a recent op-ed in the FT:

But the most important cloud on the horizon is the large tax increase that will occur next year unless there is legislation to block it. (…) That increase of $512bn is equivalent to 2.9 per cent of GDP, bringing federal revenue as a share of GDP from 15.8 per cent this year to 18.7 per cent next year.(…)

The risk of dramatic tax increases and an economic downturn next year affects the behaviour of businesses and households today. Companies that expect large tax increases in 2013 and potentially another downturn in the near future will be reluctant to invest or hire this year. And individuals who think their personal taxes may rise next year will also cut back on current spending on “big-ticket” and other discretionary items.

The U.S. consumer is in no position to continue to support the U.S. economy. In fact, it will soon stop supporting the world economy, given what Europe is going through and how China is weakening.


FACTS & TRENDS: U.S. Housing Mending


House prices remain weak in the U.S. but the underlying demand/supply data have been giving positive signals since October. Before prices can recover, supply must first decline, which has been happening. Meanwhile, demand is also coming back owing to record affordability, rising rental rates and slowly increasing credit availability. Pent-up demand is high and the recent improvement in employment conditions will help unleash it.

A better housing market will help the U.S. economy significantly.

  1. Construction employment which has lost 2.2 million jobs since 2006 would recover.
  2. Sales of home furnishings would strengthen,
  3. Banks balance sheets would improve.

Here are the facts gathered from previous News-To-Use posts:

  • Pending Home Sales Rise Again in November. The gains were broad based geographically. It is also the first time the PHSI has been above 100 since June 2007 without the benefit of any tax credit stimulus.
  • U.S. New Home Sales Increase. Still very feeble but a trend is a trend! New home sales needed a sharp decline in the inventory of existing homes for sale and that has happened. The inventory of unsold homes reached a new series low (-19.4% y/y) and it reached a new cycle-low of 6.0 months of sales.


  • KB Home on Dec. 23:

[Starts]New home deliveries rose 4% to 1,995 homes, while the cancellation rate decreased to 34% from 37% a year earlier as fewer deals fell through. The average selling price rose 2.5% to $238,400. Orders climbed 38% to 1,494 homes, and backlog—an indication of future business—grew 61%.

  • Existing home sales in November rose 4% from October’s levels to a seasonally adjusted annual rate of 4.42 million, the second-highest level of the year. Importantly, housing inventory declined to 2.58 million in November, down 18.1% from one year ago to the lowest level since the spring of 2005. Sales of existing single-family homes alone rose 4.5% m/m to 3.950M, up 12.9% y/y.


But real-estate agents say markets are stalled now because sellers aren’t willing to reduce prices furtherand are keeping their homes off the market rather than settling with buyers seeking deep discounts.

Buyers, meanwhile, remain frustrated by inventory that they say is unattractive or overpriced. A shortage of inventory has “caused buyers to go away,” said Ron Leis, a real-estate agent in Sacramento, Calif. “It’s our biggest issue right now. They lose interest because there just isn’t anything to buy” that meets their requirements.


Household formation has slowed drastically in recent years.  And though the slowdown in household formation coincided with the recession, as the economic recovery began and strengthened last year, household formation has yet to pick up.

Household Growing Pains

Macroeconomic Advisers (MA) recently examined Census Bureau population projections and “headship rates” (the share of people that head a household in various age groups) and projected that 13.7 million new households will form in the decade ending 2020.  Given vacancy rates and the size and age of the current housing stock, MA forecasts that these 13.7 million households are likely to spur the construction of 15.9 million units over that 10-year period.

  • Dec 20: Toll Brothers recently indicated that Q1 2012 new orders through early December were up 20% y/y. Last week, Hovnanian Enterprises said that November orders jumped 31% YoY.
  • Mortgage applications to purchase a home rose 8.3% last week to the highest level since April.foreclosures
  • Foreclosures remain high but keep in mind that 2 states, Florida and California, carry 35% of the foreclosed housing stock. Housing demand is slowly picking up across the US while “normal” inventory is diminishing rapidly. 
  • image_thumb[4]The IMI is designed to track housing markets throughout the country that are showing signs of improving economic health. The index measures three sets of independent monthly data to get a mark on the top improving Metropolitan Statistical Areas. The three indicators that are analyzed are employment growth from the Bureau of Labor Statistics, house price appreciation from Freddie Mac, and single-family housing permit growth from the U.S. Census Bureau. NAHB uses the latest available data from these sources to generate a list of improving markets. A metro area must see improvement in all three areas for at least six months following their respective troughs before being included on the improving markets list.

Even California is showing signs of healing:

  • California’s existing single-family home sales increased 0.9% MoM in October, on a seasonally adjusted basis, rising to an annual run rate of 493,240 units (+8.5% y/y). California’s non-seasonally adjusted pending sales index (PHSI) increased 11% y/y in October. . California single-family listed inventory decreased 7% y/y to 217,848 units and while significant shadow inventory remains and will gradually surface, the combination of rising real demand and reduced supply should help stabilize prices.
  • Nov. 28:

(…) monthly mortgage payments on the median priced home—including taxes and insurance—are lower than the average rent levels in 12 metro areas, according to data compiled for The Wall Street Journal by Marcus & Millichap, a real-estate brokerage that tracked 27 metro areas. It remains less expensive to rent than to buy in 15 cities. But affordability hasn’t done much to lift the sagging housing sector because many would-be buyers are unwilling to purchase a home or unable to qualify for a mortgage.

Note that of the 15 metro areas where mortgage payments are higher than rent levels, 6 are on the US west coast.

One hopeful sign is that inventories have fallen from their bloated levels of one year ago. (…) Visible inventory was down sharply in several markets, including by almost half in Miami and 40% in Phoenix.

Another example is South Florida, a hard hit bubble area, where the demand/supply equation is shiftingrapidly. Sales were 22,000 last month while residences for sale shrunk to 45,000.

  • Nov. 24:

SOUTH FLORIDA HOUSING MARKET STRENGTHENING: CondoVultures.com reports that South Florida’s residential resale inventory has decreased by 58% in the last 3 years. Nearly 108,000 residential properties were on the resale market in the tricounty South Florida region on Nov. 24, 2008.

Some three years later, the number of condos, townhouses, and single-family houses on the resale market in Miami-Dade, Broward, and Palm Beach counties has shrunk to fewer than 45,000 residences as of Nov. 21, 2011, according to analysis by the licensed Florida brokerage CVR Realty™.

The number of residential properties under contract in South Florida has spiked to nearly 22,000 – a large chunk of which are all-cash deals – as of Nov. 21, 2011, according to the analysis based on Florida Realtorsassociation data. Back in 2008, the pending sales in Miami-Dade, Broward, and Palm Beach counties totaled slightly more than 9,300.

(Many charts in this posts from Haver Analytics)

More?:  Facts & Trends



Investments need to be based on solid facts, first and foremost. What are the facts, plain and simple. What is really happening, not what we wish, hope or pray for. We need to know what is, not what could, might or should be.

The world is not static and momentum is also important. Facts being well established, a good understanding of trends is therefore paramount to good investment returns. Trends are not forecasts. Trends tell of actual changes from a previous state. Up, down or sideways. Trends are also facts.

  • Knowing the facts
  • seeing the trends and
  • understanding the agents of change to appreciate the quality (reliability) of the trends.

This is what Facts & Trends seek to provide.

Facts & Trends will be a new regular feature on News-To-U(se): I will expose the facts on a number of key themes and track their trends, hopefully helping us making better informed and more timely investments. Readers are invited to contribute, confronting the facts and/or the trends, or volunteering their own.