Orlando's Outlook: Housing, autos poised to drive stronger second half
Bottom line The Commerce Dept. revised first-quarter Gross Domestic Product (GDP) down a tick to a gain of 2.4%, right in line with our expectations. Modest improvements in consumer spending, business fixed investment and net trade were collectively offset by a larger decline in government spending, a smaller inventory build, and a weaker gain in housing. In our view, the fiscal drag which has impeded economic growth for the last two quarters is likely to spill into the current quarter, as well. But we believe that organic strength in both housing and autos—in conjunction with a developing wealth effect—will lift the U.S. economy onto a more robust growth trajectory in the second half of 2013.
GDP revised down The first quarter, initially flashed at a gain of 2.5%, was revised down to 2.4%. Here’s what drove the revision:
Consumer spending strengthens Personal consumption expenditures (PCE), which account for 70% of GDP, was revised up to 3.4% growth (the largest gain since the end of 2010) from a preliminary estimate of 3.2% and a 1.8% increase in the fourth quarter of 2012.
- Business capex improves Real business fixed investment was revised up a tick to a 2.2% gain, compared with a robust surge of 13.2% in last year’s fourth quarter. Business structure investment, such as factories and office buildings, fell by 3.5%, down sharply from a preliminary 0.3% drop and versus a strong fourth-quarter gain of 16.7%. Business equipment and software spending rose by a revised 4.6%, versus a preliminary increase of 3.0% and an 11.8% fourth-quarter jump.
- Net trade mix shift Exports rose by a less-robust 0.8%, down from a preliminary gain of 2.9%. But imports were revised down to an increase of 1.9% from a preliminary bump of 5.4%.
- Slower inventory build The pace of inventory restocking slowed to an increase of $38.3 billion, down from a preliminary gain of $50.3 billion in the first quarter. The silver lining, however, is that lower inventory levels now will set the stage for a second-half rebuild, which will boost GDP.
- Sharper defense cuts drive government spending lower Total government spending, which declined for the tenth time over the past 11 quarters, fell at an even sharper pace than was originally reported, declining by a revised 4.9%, versus a 4.1% preliminary drop. The decline was driven by a 12.1% plunge in defense spending (versus an 11.5% preliminary drop), on the heels of a 22.1% fall during the fourth quarter, due to President Obama’s planned cuts in defense, representing the largest back-to-back quarterly declines in defense since the military demobilization in the Korean War in 1954.
- Housing gains slow While housing is up for eight consecutive quarters, residential investment was revised down to a more modest first-quarter gain of 12.1%, versus a stronger preliminary gain of 12.6% in the first quarter and a blistering 17.6% jump in the fourth quarter.
Washington’s fiscal drag Contrary to popular belief on Pennsylvania Avenue, fiscal policy matters, and the combination of tax hikes at the beginning of this year and the automatic spending sequester that went into effect on March 1 have already conspired to produce a disappointing 0.4% fourth-quarter 2012 GDP gain and the aforementioned 2.4% increase in the first quarter. As the spending sequestor gains traction, we expect that second-quarter growth will decelerate to our muted estimate of only 1.7% growth.
Developing wealth effect But the good news is that as businesses and consumers begin to get used to their higher tax rates and reduced levels of government spending, we believe that their negative impact on consumption will begin to fade. Moreover, as equity and real estate prices continue to rise—as we expect they will—then that new-found wealth effect will eventually offset the deleterious economic and psychological impact from fiscal policy drag. Over the past year, for example, housing prices have risen by about 11% nationally, while the S&P 500 has surged by more than 30%, and we believe that both of these positive trends have longer-term legs.
Autos revving back up Over a roughly four-year period during the depths of the Great Recession, total vehicle sales plummeted from a peak of 18.4 million annualized units in December 2004 to 9.0 million in February 2009. From that point, auto sales have recovered briskly, surging by 70% over the ensuing four years, back to 15.33 million units in February 2013. Due largely to the temporary spring swoon, however, auto sales then slipped by 3% over the next two months to 14.88 million in April 2013. With low-cost financing plentiful and with consumers beginning to look across the proverbial valley to a stronger second-half economy, we believe that auto sales are poised to re-accelerate. The average age of the auto fleet in the U.S. is about 11 years old at present—nearly 50% older than normal—which suggests to us that auto sales should remain well above replacement demand at 14.0 million units for the next several years, and possibly approach 16.0 million annual units or more.
Housing should remain a bright spot We believe that this sequential first-quarter slowdown in housing was largely due to seasonality and weather-related issues more than anything else, as we fully expect housing to reaccelerate strongly into the spring and summer months. From the bottom of the cycle in September 2011, we remain very confident that housing is perhaps 18 months into a robust five- to-seven-year recovery.
- Mortgage rates are very low By historical standards, mortgages are attractively priced: 30-year fixed-rates are currently at 4.11%; 15-year fixed-rate at 3.26%; jumbos at 4.26%, and five-year adjustables at 2.96%. With benchmark 10-year Treasury yields soaring from 1.60% to 2.20% over the past month, mortgage rates have started to inch higher, which should spark a frantic wave of interest among potential home buyers.
- Easier bank lending standards But appraisals are still too conservative, as appraisers remember all too well getting burned during the last down cycle.
- Housing-market index (HMI) strong A key leading indicator reflecting home-builder confidence, the HMI plunged from a peak of 70 in July 2005 to a record trough of 8 in January 2009. It recovered slightly to 14 by September 2011, which we believe represented the bottom of the housing cycle, before more than tripling to 47 in January 2013. The HMI eased back to 41 in April because of weather and seasonality, and has recently started to re-accelerate, with a move back up to 44 this month.
- Starts and permits recovering Both bottomed at record lows of about 500,000 annualized units in 2010, and they have since doubled to the 1.0-million level in recent months. But they need to triple off of their trough to get back to normalized 1.5-million annualized unit levels, and we believe a catch-up run to about 2.0-million units is likely over the next few years.
- Affordability is high The combination of rising incomes and attractively-priced houses hasn’t been this favorable in more than 40 years.
- Mortgage delinquencies, foreclosures falling sharply Delinquencies, which peaked in the first quarter of 2010 at 10.06%, have since fallen to 7.25% in the first quarter of 2013. Foreclosures peaked at 4.63% in the first quarter of 2010, and are now at 3.55% three years later.
- Household formations improving Formations troughed at a record low of a negative 200,000 households in 2009, but they’re now back to the historical average of 1 million annualized formations. With a firmer job market starting to drive young people off of their parents’ basement couch and out of a shared-household living situation, however, we can envision household formations approaching a catch-up level of 1.5 million or more a year for the next several years. Shared households peaked at 1.3 million in 2010, and plunged to a negative 200,000 in 2011.
- Prices are rising For the 12 months that ended in March 2013, the Case-Shiller index of home prices rose by 10.9%, the largest such gain in seven years. All 20 of the component cities posted year-over-year gains.
- Existing home sales strong Sales of previously-owned homes, which account for about 93% of the market, rose in April to their highest level in more than three years at 4.97 million annualized units. The cycle had peaked at 7.08 million in 2005, and subsequently troughed at a 13-year low of 4.11 million in 2008. Foreclosures and distressed sales account for 18% of this total, the lowest such level since October 2008.
- New home sales accelerate Sales of new homes in April rose to their second-highest level in five years at 454,000 annualized units. Inventory of new homes on the market at 156,000 units is more than 70% less than the inventory peak of 572,000 units in July 2006.
Confidence rising The Conference Board’s Consumer Confidence index rose to its highest level in more than five years in May, soaring to 76.2 from 61.9 in March and 69.0 in April. Not to be outdone, the Thomson Reuters/University of Michigan’s consumer sentiment index for May rose to its highest level in nearly six years, with a final reading of 84.5 in May, versus 76.4 in April. This suggests to us that the auto and housing markets should re-accelerate into the late spring and summer months, which should help to drive stronger second-half economic growth, compared with tepid first-half levels.