Stocks have had a great start to 2023, and the economy continues to surprise to the upside. In particular, China is showing improvement. If one of the world’s largest economies is quickly advancing, what does that do for the odds of a U.S. recession? Our base case has always been the U.S. will avoid a recession in 2023. We are still in that camp, and an improved Chinese economy does little to change our view.
- Market and economic sentiment remain bearish.
- Negative sentiment could be positive for stocks down the road.
- Housing is another potential positive for the economy.
- Housing was a drag on GDP in 2022 and is likely to have been so in the first quarter.
- However, the housing picture is improving, which is positive for the economy.
- Sales are rising, housing starts are up, and builder confidence is rebounding.
What’s fascinating is various signs of sentiment are showing over-the-top negativity. From a contrarian point of view, this type of negativity could be a bullish catalyst. Think about it — if everyone is bearish, then they’ve already sold, leaving nothing but buyers. So, any good news (or even less bad news) could spark a rally.
If this sounds familiar, it is because we’ve been bullish before for this very reason. In mid-December we moved to overweight equities at a time when many were spouting end-of-the-world scenarios. We wrote about this here. Now after a great start to the year for stocks, we are hearing some of the same negativity.
Here are a couple signs that suggest investors are overly pessimistic, which could prove positive for stocks.
- The recent Bank of America Global Fund Manager Survey showed the most underweight stocks relative to bonds since the global financial crisis. This survey reviews more than 600 money managers and clearly shows the crowd is defensive. Note how popular stocks were relative to bonds in January 2022, just as stocks peaked and entered a vicious bear market.
- JP Morgan published a survey of institutional investors that showed 95% of those surveyed expect stocks to drop by the end of the year. Only 5% expect stocks to gain, and virtually no one expects stocks to gain significantly by the end of the year. This survey amazes us, but it shows just how much potential there is for a surprise rally.
This negativity is rubbing off on Americans. A CNBC survey showed public pessimism on the economy hit a new high recently. According to the latest CNBC All-American Economic Survey, 69% of those surveyed held negative views about the economy now and in the future, the most pessimistic levels ever. Just 24% said it was a good time to invest in stocks, the lowest in the 17-year history of the survey.
On the Carson Investment Research team, we aren’t about being contrary for the sake of being contrary. But when the macro backdrop, market technicals, fundamentals, and sentiment all line up in our favor, we will take the road less traveled and go against the herd. We continue to think the economy is on better footing than most expect, thanks to a strong consumer and healthy employment backdrop.
Another (Potential) Positive for the Economy: Housing
Housing was the biggest drag on economic growth last year. The economy grew by 2.1% in 2022, but that overcame a 0.93%-point drag from residential investment, i.e., housing. In fact, it’s been a drag on GDP growth for seven straight quarters, through the end of 2022. It got worse over the last three quarters of 2022 as mortgage rates surged from below 3% to just above 7%, thanks to an aggressive Federal Reserve. Housing is likely to have been a drag for the eighth quarter in a row in the first quarter of 2023. But things may be looking up for the rest of the year.
People Want Houses, But There Aren’t Many
Existing home sales fell 34% in 2022 but are up 10% over the first three months of this year. Some of that is because mortgage rates have pulled back from the peak level of 7%+ last fall. However, rates are still high, and they are significantly higher than a year ago when 30-year mortgage rates were around 3%.
In fact, based on the median price of an existing home, and assuming a 20% down payment, monthly mortgage payments have jumped from about $1,200 at the end of 2021 to $1,900 as of March. That’s not because of an increase in home prices — the median price increased about 5% to $376,000 during this period. It’s because the 30-year mortgage rate jumped from about 3.1% in December 2021 to 6.5% in March 2023! In short, affordability is low.
Nevertheless, as rebounding home sales have shown, there’s still pent-up demand. A big factor is the population of 25-34 year olds, which is prime homebuying age, is at record highs. For perspective, the number of potential first-time homebuyers is up from 39.5 million in 2006 to 46.1 million today. Pent-up demand was evident in the latest existing home sales report. Properties typically remained on the market for 29 days in March, and 65% of homes sold in March were on the market for less than a month. So, demand is clearly strong despite high mortgage rates.
The problem is there aren’t many homes for sale. Inventory of existing homes is currently at 2.6 months of supply at the current sales pace, which is well below a normal range of 4-6 months.
You can probably guess why inventory is low. Most homeowners are “locked-in” to their homes since they got their existing mortgages at ultra-low rates. As a percentage of disposable income, mortgage debt service payments were just 4% at the end of 2022. That’s lower than it was pre-pandemic and lower than at any point during the last four economic expansions. This is great from a consumption point of view, since it means households are less financially constrained. However, it also means a lot of homeowners are unlikely to move. Who would want to sell their low-rate mortgage and buy a new home at 6.5%?
New Buyers Pushed to New Homes
Of course, those who must move have little choice but to buy a house. And if there’s not much inventory in the existing home market, they will look for new houses. That is why new home sales are up 16% from last September through February. There’s relatively more inventory in this market, about eight months of supply at the current sales pace. However, on an absolute basis, the inventory of new homes is under 450,000 — less than half that of existing homes, which is close to 1 million.
The inventory of completed homes is rising while the number of homes under construction is falling, as supply-chain issues fade. Homebuilders are also starting fewer homes than they are completing. This is not a problem now but does mean supply next year is likely to be constrained. The good news is new housing starts may have bottomed — starts are up 7% over the past five months through March.
Homebuilders are Feeling Good, and the Market is Responding
Combine the pent-up demand with relatively low supply, and builders are feeling good, as witnessed by a rebound in homebuilders’ confidence.
The market is sensing this conviction. The SPDR S&P HomeBuilders ETF is up almost 16% so far this year, through April 20, versus 8.1% for the S&P 500. Since Sept. 30, the HomeBuilders ETF is up 27.6%, versus 16.4% for the S&P 500.
This was validated by the April 20 earnings report of D.R. Horton, the nation’s largest homebuilder in terms of volume. It beat revenue and earnings estimates by wide margins, sending the stock up by 5.6% over the day. But it was forward-looking guidance that was especially positive: D.R. Horton sees higher revenue in 2023 and expects to close on 77,000 to 80,000 new homes, well above estimates for 71,000.
More activity in the new home market is even better for GDP growth. It involves activities such as design and construction, as well as large household appliance purchases, which is not the case for existing homes.
Single-family home construction makes up almost 40% of residential activity within GDP. And over the last three quarters of 2022, it crashed 23%, which is why housing was such a big drag on GDP last year.
The good news is we may have seen the back of that, with single-family construction no longer sinking. That by itself would be a positive for the economy. Any rebound, if it happens, will be even better.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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