HOUSING STARTS: The Critical Leading Economic Indicator

The Conference Board1 releases an index of leading economic indicators that include 10 indicators: Average workweek, Jobless claims, Consumer goods orders, ISM new orders, Capital goods orders, Building permits, Stock prices, Credit conditions, Interest rate spreads, and Consumer expectations.

This index has been down every month for the last 16 months. However, there has been no sign of an economic slow-down with GDP growth of over 4% in Q3 and Q4 GDP now tracking at over 2%. Over the last 6 months, most components were strongly negative including interest rate spreads, credit conditions, ISM new orders, and consumer expectations, but building permits, stock prices, new orders, and initial jobless claims were all positive.

We believe that by far the most important leading indicator of the economy is building permits/housing starts. In fact, 8 of the last 9 US recessions have been precipitated by a plunge in housing starts, with the average decline to a level below 900k units with a low of 500k units reached during the Great Financial Crisis. The average annual housing starts over the last 60 years is 1.5MM units. The only recession that was not preceded by a housing plunge was the shallow 2001 recession which was primarily a tech bust recession and coincided with a dramatic secular decline in global interest rates caused by an increase in retirement and sovereign wealth savings.

The decline in housing starts is caused by tight monetary policy that increases both short and long-term interest rates, causing a precipitous decline in housing construction. Therefore, the housing sector is the primary transmission mechanism of monetary policy. The decline in housing starts causes a plunge in construction employment and a sharp decline in manufacturing activity as most consumer durable consumption is driven by housing. The decline in employment in these sectors causes a decline in consumer consumption as laid-off workers curb spending which exacerbates the recession.

We have been correct over the last 18 months forecasting that the US was not likely to enter a recession, as we have focused on housing market conditions.

• The US housing market is extremely resilient right now as there is an all-time low of approximately 1.1MM homes for sale vs. a normal level of approximately 2.5MM units.

• Housing starts did decline in 2022 from a high of 1.8MM to 1.35MM units at the end of the year.

• Housing starts, however, have remained stable during 2023 with the most recent level at 1.37MM units. This is in line with the historical average of 1.5MM and well above the average recession level of 900k units.

We are bullish about the US stock and bond markets for 2024, with a year-end price target on the S&P 500 of 5,000 and a target for the US 10-year treasury yield of 3.5-4.0%.

• Our bullish view is driven by our view that global interest rates will decline next year as foreign central banks are forced to ease monetary policy, particularly in Europe which has already entered a recession.

• In addition, we continue to expect that the US will avoid a recession despite very tight monetary policy due to the resilient housing sector.

If the US avoids recession, earnings growth is likely to continue, resulting in the current estimated S&P earnings for 2025 of $270 remaining stable. Our 5,000 target represents an 18.5x multiple of earnings, which is reasonable if treasury rates drop below 4%.

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1Top 10 leading economic indicators (LEI) list by The Conference Board, https://www.conference-board.org