There's an Old Saying among Commodity Traders: The Cure for High Prices is High Prices
Persistent underinvestment in American housing stock leads to persistent higher cost of shelter.
Houses are remarkable things. They're places to sleep and eat, to enjoy the company of friends and family, an expression of personal taste and interest, status symbol, cultural artifact, design object, hobby and investment. Over the past year they've even become workplaces for many people around the world. They serve so many functions in our lives, it's no wonder the Ancient Greeks and Romans each propitiated a single goddess to ensure their maintenance and good function.
In fact, people in the United States spent so much money on their homes last year that you would never be able to tell that there was a deep, global recession going on from looking at the earnings and share prices of durable goods, furniture and home improvement companies. In addition to improving their own homes, many bought larger homes to accommodate growing families, or to obtain extra space for home offices or leisure. The Federal Housing Finance Agency house price index is reflective of the increase in demand that resulted in an increase in price. Compound annual growth rates in housing prices over the last twenty years have been increasing rapidly, growing 72.5% from 1991 (4.0%) to 2012 (6.9%).
Year-over-year price changes for the US market increased by 15.7% from April 2020 to April 2021. The chart below demonstrates that the increase in price is consistent across region and in magnitude.
And while the demand for space over the past year would have been uniquely high given the context in which the price rises occurred, it's clear that it was just an acceleration of an already-existent trend. Starting in 2011, house prices began to recover from the 2007 crash, and have only accelerated in their climb.
In the past, the United States tax code had been pretty generous to homeowners, allowing them to deduct mortgage interest expense and state and local taxes from their gross income before calculating federal tax obligation. This mechanism served as an unofficial subsidy to consumers to encourage them to buy homes, rather than rent them (the same exemptions are not applicable for those who rent). What's interesting is that the 2017 Tax Cuts and Jobs Act effectively ended this subsidy by capping the amount of interest expense that is deductible, implementing double-taxation of gross income in the repeal of the state-and-local tax (SALT) deduction, and raising the dollar amount of the standard deduction, effectively extending similar amounts of tax shield to renters as it formerly did to homeowners. As you can see from the increasing pace of price increases, however, this did nothing to depress their ever-upward march.
Houses, for all their idiosyncrasy, are nonetheless still goods, and are subject to the surly bonds of supply and demand. We would expect higher prices to be an indication of higher demand, or lower supply, or both. As you can see from the chart below, it is an interaction of the two that seems to have created the current market price dynamics.
Price has been less volatile since the Great Recession, and since 2013 has been entirely positive. Yet the inventory of houses has barely increased, and has remained more or less constant. Higher prices should serve as a signal to homebuilders that the housing market is demanding more homes be built. To an extent we saw this in today's economic data releases, as Building Permits came in positive (although marginally lower than forecast), as did Housing Starts (although marginally higher than forecast). It seems like the market has gotten the memo that if they build homes, consumers will come. Much has been made of the increase in finished home prices lately, as higher input costs resulted in homes that cost more than forecast, but so long as economic activity remains somewhat subdued--the more so due to the contagiousness of the delta variant of the coronavirus--housing doesn't have to compete with other consumer goods as much for wallet share.
We expect the decade-long underproduction of housing, and the ongoing demand for more square footage to contribute to continued strength in housing prices. This should translate into continued demand for lumber, copper, durable goods, infrastructure, and concomitant broadly-based economic activity in the United States. Additionally, skilled labor should benefit from the increased demand, although it is not yet clear from where this labor will be sourced. Until inventory has increased sufficiently to meet demand, or demand falls off a cliff, we expect residential real estate to outperform, and for our investors' own homes to serve as an effective store of value.
Still, this is not an unalloyed good. Shelter, food and energy are the most price inelastic demands that individual consumers have. A disproportionately large share of income goes to housing for most workers, especially those in the urban, coastal areas, as well as areas that depend upon knowledge workers. This amounts to 33% of income, arguably much too high. If prices continue to rise more quickly than inventory, then the difference will be felt directly by savers in the form of erosion of their buying power of the thing they buy the most of.
A Crazy Day on Wall Street
Monday was witness to one of those trading days that economists and market watchers alike have difficultly explaining. Long-dated bonds rallied, and equities dropped precipitously, ostensibly in response to the escalating number of cases of infection due to the more-contagious strain of the coronavirus, the delta strain. Unfortunately, hospitalizations and deaths are both on the rise, while vaccination rates--especially in localities where conservative politics predominate--stalled. Coupled with lukewarm growth data, it appeared for all of a day that the economic expansion was waning and the long day's journey into night had begun.
Not to discount these factors, but the script flipped today as the reopening trade unwind suddenly unwound and markets returned to the positioning they held prior, one more appropriate to an economic expansion. Major indices, and especially economic expansion-sensitive small capitalization stocks rallied remarkably, providing one of the clearest examples this year either of the inefficiency of markets, or their mercuriality, or both.
Cryptoassets Struggle to Hedge against Inflation
Digital assets have been on a downward trend of late, and are currently trading well below the peaks they saw earlier this year. Bitcoin, the largest of these, traded below the psychologically important level of $30,000 USD/1 BTC, effectively entrenching itself in its new trading band. It currently trails the S&P 500 in annual gain, which is not the way it was supposed to happen. This support level may entice institutional investors back into the market, or may end this round of the "Cryptoassets Eat the World" theory of everything that we've discussed in past.
Of the many justifications offered for its existence, one of the most prominent is that Cryptoassets, given their programmed scarcity, are an effective store of value vis-a-vis fiat currencies, the latter of which can be printed ad infinitum. (Someone should ask Chairman of the Federal Reserve Jay Powell if this is actually the case.) Unfortunately, as inflation for reopening-related consumer goods has increased, Cryptoassets have decreased at the same time, putting into question whether they are effective hedges against inflation. Given this unrepresentative sample, we will reserve judgment; suffice it to say that its evangelists face more skeptical crowds of potential converts.
Robinhood Goes to Market
Our more dedicated readers know that goodstead isn't sure that trading app-sponsor Robinhood Financial LLC is on the side of investors. Add to the firm's recent string of regulatory woes a record-setting fine from the Financial Industry Regulatory Authority (FINRA) of nearly $70 MM for deceptive practices and trading outages that cost its investors real money.
After putting this small issue of fraudulent behavior and reckless negligence behind it, Robinhood is now ready to list its shares for public trading in an offering reportedly worth $2 B at a valuation of $33 B. Disclosed in their offering materials was the fact that in 2020 they compensated their Chief Legal Officer $30.1 MM--a level that would be considered, well, high for an executive of that type, and probably make Mr. Dan Gallagher one of the best paid lawyers in the United States. We are sure that in addition to his pay package, he enjoys excellent Directors and Officers and Errors and Omissions insurances. We earnestly hope that Robinhood develops a culture of regulatory compliance excellence, and is able to well-balance their focus on growth with their responsibility to their investors and the global capital markets in which they operate. Based on the discount at which the stock is set to debut, it would appear that institutional investors remain wary of regulatory action yet to come.
Off We Go Into the Wild Blue Yonder
Lastly, commercial spaceflight got a little bit closer over the last few days. By now everyone has seen the cowboy-hat donning billionaire Jeff Bezos accomplish his civilian trip into near space today. Congratulations to Mr. Bezos and Mr. Branson, too, on never stopping dreaming. Per aspera, ad astra.