Orlando's Outlook: Is millennial stress weighing on housing and autos?

06-30-2017

Bottom line Across the U.S. economy, consumer confidence remains elevated at multiyear highs, while spending during the important Christmas and Easter seasons this year were both at 5-year highs. But as the pace of baby-boomer retirements begins to accelerate, the new generation of millennials—defined as those individuals born between 1982 and 2004, who are coming of age now—will play an increasingly more important economic role in society.

Over the last three months, however, the labor market has downshifted to its slowest hiring pace in five years, while student loan debt is now at $1.3 trillion. The advent of new technologies also continues to rapidly challenge the status quo of life as we’ve always known it. Consequently, millennials’ spending patterns are not the same as those of previous generations, and recent data suggests that the housing and auto sectors are two industries whose recent stumbles could be affected by their new, more parsimonious behavior.

Student loan debt soars It more than doubled over the past just nine years, from $611 billion to $1.3 trillion today. True, student loan debt accounts for less than 11% of total household debt, compared with 71% for housing-related debt, 9% for auto debt and 6% for credit cards. But the sharp increase in student-loan debt has a negative psychological effect on their behavior, which includes delaying life, such as getting married, starting a family or buying a house or car. Banks have exacerbated this trend by slowing loan growth to this debt-challenged cohort.

Housing plateau? Despite a strong recovery in the housing market from the depths of the Great Recession to decade-highs in both new and existing unit home sales in March 2017, there are some chinks in the armor. The rate of homeownership, which peaked at just over 69% in 2004, has since plunged to a half-century low of 62.9% in the second quarter of 2016. We’re marginally above that trough level at 63.6% in this year’s first quarter, but that’s still below the long-term average of 65-66% since the federal government started to collect this data in 1960. Millennials have been reluctant to make the long-term financial commitment to purchase a home, opting to rent instead. The pace of household formations, the strength of the labor market, mortgage rates and wage inflation will collectively dictate the direction of this own-versus-rent tradeoff in coming years. 

Millennial multiplier effect Millennials have recently valued location over open spaces, so they have opted to live in a city rather than in the suburbs. With land in cities much more expensive, the prices of city homes are too expensive for them, forcing them to rent instead. But renting involves less spending than on a house, which reduces the economic multiplier associated with renovating, decorating, and buying appliances.

Here are some important housing-related metrics that we’re watching closely:

New home sales (an important housing leading indicator, because they are calculated when a contract is signed, typically several months before closing) peaked at 644,000 units in March, a 10-year cycle high. April fell by nearly 8% to 593,000 units sold, although May improved slightly to 610,000 units.

Existing home sales (a lagging indicator, because they are calculated when a purchase contract actually closes) now accounts for 90% of total homes sales. They also peaked at a new 10-year cycle high in March at 5.7 million, although April slipped by 2.5% to 5.56 million annualized units. May recovered slightly to 5.62 million.

Pending home sales have now been negative for three consecutive months. The index dropped by 0.8% month-over-month in May, and April was revised even further down to -1.7%. A limited number of starter homes are for sale, and some of these first-time buyers are having problems qualifying for mortgages.

Housing Market Index, a measure of builder confidence, peaked at a 12-year cycle high at 71 in March, 2017, but it has since dropped to 67 in June.

The Case-Shiller pricing index, a rolling 3-month lagging average, has slowed over the past three months. Its composite 20-city index peaked in January 2017 with a robust 0.85% month-over-month gain, which has since dropped to a modest 0.28% increase in April.

Housing starts & permits (important leading indicators) have both slowed in recent months. Housing starts peaked at 1.34 million annualized units in October 2016, a nine-year cycle high, but they’re currently running at only 1.092 million, a nearly 19% decline. Building permits similarly peaked in January 2017 at 1.3 million annualized units, which was an 11-year cycle high, but they’ve since fallen to 1.168 million, a 10% drop.  

Mortgage delinquencies steadily declined from a cyclical peak of 10.06% in 2010 to 4.52% in the third quarter of 2016. But they rose for the first time in a decade to 4.8% in the fourth quarter of 2016, before easing a bit back to 4.71% in this year’s first quarter. This modest red flag bears watching.

Rising delinquencies have likely motivated banks to tighten their purse strings, at least temporarily. Residential real estate loans have slowed from a 5.78% year-over-year (y/y) increase in January 2017 to a 4.08% gain in April.

Lumber prices have risen by 30% y/y, due to a 20% Canadian softwood tariff implemented by the Trump administration. That’s important, because 28% of all softwood lumber purchases in the U.S. come from Canada, and these goods constitute about 9% of costs for homebuilders, creating pricing pressure.

Many small and mid-size homebuilder companies did not survive the financial crisis, lessening competition, with 530,000 construction firms in 2005 falling 30% to 368,000 in 2014, which has contributed to the lack of inventory. With less competition, homebuilders can increase prices.

The auto industry is weakening, with car sales down by more than 9% to 16.58 million this past May, from December 2016’s 10-year cycle high of 18.3 million annualized units sold. Inventories are at an elevated 13-year high, while the pace of auto sales has fallen to a two-year-low.

General Motors and Ford, two of the big domestic auto companies, are retrenching as they plan for a slower auto cycle. Ford announced it will reduce its white-collar work force by 10%, about 20,000 workers, and GM announced that it expects annual industry sales to fall to levels around 17 million, down from its previous forecast of 17.55 million units. That may be wishful thinking, as the industry expects to see an estimated 16.5 million annualized unit sales in June, the fourth month in a row with sales below 17 million. That’s the slowest trend since mid-2014.

Auto loans send red alert, with debt on auto loans at an all-time high and late payments on the rise the past couple of years. Data shows that about 1 in 16 car loans are 90 or more days late, a number that is raising concern. These losses were partly due to more borrowers falling behind on their payments, but also because the value of used cars started to decline. Big banks have now started reducing their exposure to auto loans, sparking the decline in car sales.

Leasing is in trouble, having peaked in 2015 and 2016, and what it has left is a large amount of used vehicles entering the second-hand market.

Another big factor in autos is the decrease in popularity for diesel cars, with society seeking to reduce diesel emissions by moving into electrification. This will force suppliers to make an adjustment in their production. Follow copper closely, as this a fundamental material for this type of car.

The sharing economy is growing. As millennials tend to move into cities rather than suburbs after college, companies such as Uber and Lyft make it easy and convenient to live without a car. The costs of insurance, parking and traffic outweigh the benefits of having one in a city. Partly due to the aging population but also to new buying behaviors, data shows that the average age for new-vehicle buyers has increased by almost 7 years from 2000 to 2015, indicating a 30% decrease in vehicle purchasing in the last 15 years because of these differences between generations.

Research assistance provided by Federated summer intern Victoria Sanzo

Happy Fourth of July, everyone!