Housing And Auto Sales Have Peaked

This article will review the latest economic data. The chart below shows the latest seasonally adjusted annual rate of sales for lightweight vehicles and new homes. New home sales peaked in March at 642,000 and auto sales peaked in December 2016 at 18.3 million. April new home sales are down 11.4% from the peak and auto sales are down 8.2% from the peak. Auto sales were up 1.8% month over month in April. The latest new home sales report was a 5 standard deviation miss from expectations. This chart is a beautiful display of the past two cycles. The 2008 financial crisis started when new home sales started to decrease in mid 2005. New home sales haven’t reached the previous cycle high because that was an artificially inflated bubble as banks were giving out mortgages to anyone with a pulse.

It’s amazing how bad the situation got. Giving out adjustable rate loans to those who couldn’t afford to pay them when rates went up was a recipe for disaster. This time the bubble is in auto loans. If you watch TV commercials or read billboards, you can see car salesman promising to give out loans with little money down and low interest rates even if you have bad credit and no job. The chart above shows how auto sales have diverged from new home sales. Even though auto sales are close to the run rate of sales from the late 1990s to the mid-2000s, auto loan debt is 43% higher than the prior cycle peak in 2007. All that debt only managed to get back to the prior cycle’s high. At least new home sales were able to set a new record at the peak of that bubble.

The last recession began in December 2007. The peak of new home sales was in July 2005. That means there was a 29-month lead time between the sales peak and the recession. If that same gap between the peak of the auto-sales cycle and the next recession occurs, the recession would start in about two years. I don’t expect the same timeline to occur because the current economy is growing much slower than the economy was growing in 2005. In 2005, U.S. GDP growth was 3.3%. It took a lot more to knock off an economy growing that fast than it would take to slow the current economy which is struggling to hit 2% growth. If the economy hits the 3.1% target the blue chip expects and the Q1 growth is in fact 0.7% then that’s an average of 1.9%. On a related note, the definition of a technical recession may have to be changed in the future because of the slowing labor force growth rate. In Japan, any GDP growth which is positive is a great report because its population is declining.

While the U.S. economic data is weakening, the European data is strengthening. This has global asset allocation implications because the U.S. has an outsized percentage of investors’ money. Global investors have just started having net inflows into the U.S. stock market. As usual, their timing looks bad. The question remains if the Nasdaq will lose its luster as money flows into Europe. As you can see from the chart below, Markit’s Flash Composite Purchasing Managers’ Index was 56.8 in May. This implies the Eurozone quarter over quarter growth will accelerate as the GDP and PMI have had a tight correlation historically. The manufacturing PMI was 57.0 which is a 73-month high. The service sector’s PMI was 56.2 which is two tenths off April’s reading which was a 6-year high.

Besides asset allocation implications, the latest reports have implications for European monetary policy. The ECB has recently surpassed the Fed and the Bank of Japan for the largest central bank balance sheet. The average selling price for goods and services increased at the second fastest rate since July 2011. Input costs declined to a five-month low which may indicate the rate of inflation may slow in the future. The ECB hopes it will slow because, if it doesn’t, policy changes will be needed. The current expectation for quarter over quarter GDP growth is 0.4%. The headline below is the type of headline we’ve gotten used to in this era run by extraordinary central bank policies. If growth surprises to the upside, the $60 billion of bond purchases may need to be halted completely in December when the current policy expires. With central bank action, good news can be bad news because the purchases have been holding down Italian interest rates. If the ECB isn’t involved in the market, a few negative headlines in Italy can spike borrowing costs and push it into a recession.

With the U.S. raising rates and potentially unwinding the Fed’s balance sheet, it would make sense for the ECB to stop buying bonds. To summarize, Europe’s economy is stronger than America’s, yet the ECB is way more dovish than the Fed. It’s buying bonds, while the Fed is about to start selling them. That weird divergence probably won’t last long. Since the Fed has never done such an unwind of this magnitude, I’m skeptical of it until it starts. Even if it doesn’t go through with the unwind as fast as expected, the ECB stopping its purchases would be a net global tightening.

Conclusion

New home sales and auto sales have slowed from their peak which signifies that the economy is slowing. Auto sales need to be eyed closely because the $1.17 trillion debt is going to wreak havoc on the economy when the loans soar. It’s interesting to see how the 43% debt increase hasn’t had an outsized effect on sales. This may be because of millennials. They have too much student debt to buy a car. There’s also a trend towards adults getting their license later in life which is a long-term headwind on sales. From 1983 to 2014 there was a 16% decline in licenses for people ages 20-24.

It’s worth watching the European economy to see if the latest strength causes money to flow from the American stock market to the European one. The ECB halting its bond purchases in December could hurt the Italian economy in 2018.

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