Global Macro Strategy

A weekly analysis of timely economic strategy issues from Wells Fargo Investment Institute.

August 23, 2016

Ken Johnson, Global Research Analyst
Chris Haverland, CFA®, Global Asset Allocation Strategist

New Home Sales/Sentiment Data Fuel Housing Optimism

  • Today, robust new home sales for July were announced. Earlier this month, the National Association of Home Builders/Wells Fargo Housing Market Index released upbeat builder sentiment data. These trends suggest that more new home construction could be on the way.
  • Low interest rates, improved household finances, and pent-up housing demand lead to our optimistic view for housing (and the U.S. economy).

What it may mean for investors

  • Acceleration in housing could lead to a supportive environment for the Materials, Industrials, and Consumer Discretionary sectors and for Financial firms, particularly those with mortgage- and construction-lending exposure.

July new home sales data, released today, fueled rising optimism for the U.S. housing market, as sales rose 12.4 percent to a seasonally-adjusted annual rate of 654,000 units, the highest since 2007. This represented an increase of 31.3 percent over new home sales in July of 2015. Additionally, last week, the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index released upbeat builder sentiment data. This, combined with new housing starts reaching a five-month high last month, suggests a firming market for new home construction—and signals rising strength across the U.S. housing market.

Chart 1. U.S. New Home Sales: 2010 to PresentChart 1. U.S. New Home Sales: 2010 to PresentSource: Bloomberg, 8/22/16

Last week, the NAHB/Wells Fargo Housing Market Index released data from its monthly survey of builders that also signaled a brighter outlook for housing. The index serves as a leading indicator of current housing-market conditions and the rise (or fall) in single family housing starts and permits. In August, the overall NAHB/Wells Fargo Housing Market Index rose by two points to 60 (a reading above 50 indicates more builders view conditions as good (than poor)).The index’s builder sentiment survey consists of three components: current sales conditions, sales expectations, and buyer traffic. In August, two of these three components rose, with the component gauging current sales conditions increasing by two points to 65 and sales expectations for the next six months rising by one point to 67. (The component measuring buyer traffic fell by one point to 44.) These are some of the strongest figures seen all year—suggesting that the recovery in new single family housing starts is likely to continue. As noted, a strong reading for builder sentiment typically leads to a rise in housing starts. Chart 2 illustrates the upward momentum we have seen in both measures since 2011. In fact, July marked the second straight month that housing starts rose (the increase was 2.1 percent last month).

Chart 2. Housing Starts and Builder Sentiment (in NAHB/Wells Fargo Housing Market Index)Chart 2. Housing Starts and Builder Sentiment (in NAHB/Wells Fargo Housing Market Index)Source: Bloomberg, 8/19/16

Why are builders optimistic? This outlook likely stems from low interest rates, better household finances, pent-up demand and limited housing supply. The first three factors should help to fuel consumer housing purchases, while limited housing supply encourages builders to continue building new homes.

  • Low interest rates—Rates have been at historically low levels for some time. Even though the recent release of Federal Reserve (Fed) minutes showed a rate increase is possible this year, we forecast the fed funds rate to remain at its current level throughout the remainder of 2016. Even if rates did rise by 25 basis points (100 basis points equals 1%), they would remain at levels that are supportive of housing and the economy.
  • Household finances—Consumers’ cash flow continues to improve. Job gains have been consistently strong since the unexpected drop in May. If payrolls continue to grow at a healthy pace for the remainder of this year, this should lead to increasing wages and fuel a rise in consumer spending.
  • Housing supply and demand—Millennials are now the largest demographic segment—and are entering their 30s, when increases in household formation and homeownership rates are at their greatest. This potential demand will warrant more new homes—in turn, helping to move supply and demand toward equilibrium. In addition, higher rental prices also are giving Millennials the extra push to purchase a home.

Our positive outlook for new home construction aligns with our constructive view for the overall housing market—fueled by many of the factors discussed above. Housing-industry strength could lead to a positive response by multiple equity-market sectors. One such opportunity lies within Financial-sector firms, particularly those that have mortgage- and construction-lending exposure. Rising wages and loosened mortgage-eligibly requirements should increase the volume of new mortgages, which could fuel rising revenue at a time when banks are experiencing very narrow interest-rate spreads. Construction-related lending activity also should gain from the strength in new home sales. We are currently evenweight on the Financials sector. Additionally, increased construction of new homes would boost the Materials, Industrials, and Consumer Discretionary sectors of the domestic equity market. We are currently overweight on the Industrials and Consumer Discretionary sectors and evenweight on Materials.

The domestic economy and housing sector have been through a lot since 2008. Yet, the outlook for the U.S. housing market (and economy) is improving. As the U.S. is a consumer-led economy, it is important for consumers to feel confident about where things are headed before they make purchases. This holds true whether they are thinking of purchasing a home, a car, or a pair of expensive shoes. On the other side, businesses must feel confident about the economy before they ramp up production. Many ingredients, such as low rates, better household finances, and housing supply/demand have come together to enhance housing-related confidence for both groups. Many of these factors also are positive growth indicators for the domestic economy as a whole.

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