Financial Investment — Know the Housing Cycle

(Updated on 07/25/2018)

For now, although #MortgageRates are rising, mortgage payments as % of disposable personal income remain at record low—Liz Ann Sonders

2017 was the best year since 2007 for new and existing home sales. However, there are headwinds looming.  Based on two sources that I'm following, here are analysts' concerns:^[1,2]

• Declining household formation 
• Unaffordable mortgages
• Mortgage rates are based on mortgage-backed securities (MBS), which are essentially bonds that correlate quite well with US Treasuries.  
• New tax bills

No matter you are a house buyer or seller, you should know about Housing Market Cycle because house price will not rise forever without falling.  The last housing bubble burst in 2008 should be a painful reminder of this fact.  In [3], it sums it up clearly:

It’s important to remember that the Great Recession was not caused by an unexpected event. To those who study the real estate cycle, the crash happened precisely on schedule. It was painful, but it inaugurated the next iteration of the real estate cycle.

Housing Cycle

To explain the cyclicality of  housing, I'll show you from six sources:


Source #1

As early as 1876, Henry George observed the curious cycle through which real estate markets inexorably move. His findings can be illustrated by below diagram:

Source #2

Below chart was published on realestateconsulting.com by Rick Palacios Jr (09/22/2016) and here are Rick's comments on the locality characteristics of housing cycle:^[3]

Every market has its own unique set of industry influences, supply impediments (or lack thereof), and demographic drivers. While some markets took it on the chin during the last cycle, many others were left relatively unscathed. To better answer the cycle question, we examined all of these influences across the 20 largest new home volume markets. I break down our findings below.

Note that Houston was in Phase 5 (or recession) phase in 2016 because the falling oil price.  However, the oil price has recovered and new tax-cut bills has been signed since then.  Both seems to have delayed or slowed Houston's housing downturn.

Source #3

For a comparison, Doug Short has overlaid the HPI (FHFA House Price Index) and Owners' Equivalent Rent of Residences (OER).  Below is his comments on the chart:

HPI and OER moved in close parallel from the 1991 inception date of the former until early 1999, when the two parted company and HPI began accelerating into the housing bubble. HPI then fell 20.7% over the next 48 months to its March 2007 trough. Confirmation of the "bubble" designation for house prices is the 40.1% spread between HPI and OER in January 2006. 

Is another housing bubble forming? The current spread is 22.8%.

Source #4

In [6], John Rubino think the housing bubble is back and he describes it as echo-bubble.  He attributes this housing bubble as a global phenomenon.  Here is the Case-Shiller Index of San Francisco from his article:

Alarmingly, he has also commented that:

When bubbles are followed by echo-bubbles, the bursting of the second bubble tends to signal the end of the speculative cycle in that asset class. There is no fundamental reason why housing could not round-trip to levels below the 2011 post-bubble #1 trough.

Source #5

In [7], Ironman at Political Calculations compares Median New Home Sale Price and Median Household Income.  It shows an interesting loop when housing bubble burst in 2008.

Source #6

In a podcast, Ross Kay of The Wealthy Homeowner has commented on Canadian Housing Market.  He said that it has started the correction phase in Jan 2018.  He describes there are three phases of housing cycle: contraction (already happened for over 13 months), correction (just happened) and collapse.  Once the correction phase has started, it normally lasts for 4-5 years.  And, the housing market is like an ocean liner.  When it changes speed or direction, it slows or turns gradually.  After 5 years in the future, Canadian Housing Market should have taken  26% off its current Average National House Price (current: $509 K CAD), which is equivalent to a 40% correction if the collapse happened overnight.

As for affordability, the radio show host has asked him if it could be assisted by government's building more affordable housing.  He said NO and it can only be improved by the correction of house price.

You can listen to the podcast here for details.

References

1. Outlook For New Home Construction May Be Excellent - Or Not
2. Financial Sense News Hour 01/20/2018 (audio)
3. How to Use Real Estate Trends to Predict the Next Housing Bubble
4. The Housing Cycle: Market by Market
5. FHFA House Price Index: Index Up 0.4% In November
• For an explanation of OER, see this PDF commentary from the Bureau of Labor Statistics.
6. The Housing Bubble Is Back
7. Median New Home Sale Prices Resume Slow Climb
8. Ross Kay on Canadian Housing Market
9. Housing Affordability and Growth:  Draw or Drawback?
10. Housing Affordability Index in the United States
11. THE PRICKING OF THE CANADIAN REAL ESTATE BUBBLE?
12. Trends For New Home Sale Prices At The Beginning Of 2018
13. Making Sense of Rising Rates And The Risks Ahead
14. Investment—Housing Affordability (06/27/2022)
15. The Macro Update (Q1 2023) With Eric Basmajian (EPB Macro Research; 02/23/2023)

Investment Strategies from the Falling US Dollar's Perspective

Current Economy and Stock Market Updates

Here is the summary from the broadcast of Financial Sense on 01/20/2018:

• Rising inflationary concerns^[6,7,11,20]
• High prices of commodities (incl. oil)^[25]
• The potential impact appears greatest for commodity futures given a one-percentage-point increase in inflation.^[7]
• Be warned that commodities are often more volatile than both stocks and gold.^[7]
• Interest rates moving higher^[24]
• Longer-term bond yields tend to move in line with inflation expectations, whilst shorter-term yields will be more responsive to central bank rate decisions.
• Inflation plays a very real role in how we should manage our portfolios, but it does not trump factors such as economic growth, monetary policy, or which portion of the business cycle we’re in.^[7]
• Economy is doing well
• Global wise, not just US
• Near full employment
• Increasing wages over a broad range
• Strong personal financials and buying interest
• Falling US dollars^[22-24]
• The US dollar tends to weaken when ex-US growth is accelerating given the dollar's function as the world's reserve currency.
• During global downturns, the opposite happens as the dollar tends to strengthen.^[26]
• The greenback typically gains when the US is either in a severe slump or a robust expansion — and falters in times of moderate growth.^[28]
• Housing to be watched^[14,17]
• Need to determine how the new tax bills will affect the housing this year
• In short term, the market seems to be negatively impacted by the severe weather
• "However, there's no doubt the nation's most expensive markets with high property taxes are going to be adversely impacted by the tax law," said Lawrence Yun, NAR chief economist^[21]

The Breakdown in "King Dollar"

The weekly chart of US Dollar Index doesn't look good and has broken its support level.^[8,9] The breakdown in "King Dollar" may foreshadow multiyear downtrend as depicted below.^[19]

What It Means for Your Investments?

Financial Sense Staff

2018 investment themes from the Financial Sense Staff (note that mainly from falling US dollars perspective):

• Global market (vs. US market)
• Looks attractive from both value and currency perspectives
• Commodity
• Benefits from lower US dollars and rising inflationary concerns
• Normally will be the last sector to peak before economy heading into next recession^[10]
• Deep cyclical
• Energy and materials

What to avoid:

• Bonds
• Rising interest rates mean lower bond values
• Global rates are rising, not just US
• When to invest in bonds again?
• When the economy has become overheated and Fed Reserve has raised interest rate too aggressive and economy starts weakening and interest rate falling, that's the time you returns to the bond investment

HFI Research


The breakdown in "King Dollar" also foreshadows:^[4]

• Value will outperform growth
• In HFI's view, value investors will start to reap the rewards as inflationary forces have coincided with value stocks outperforming growth names.
• Another multiyear uptrend in value and inflationary-proof names.
• Stock picker's market (vs. passive investment in ETFs)

HFI believes the following sectors will perform well over the coming years:

• Cyclicals (XME)
• MLPs (AMLP, AMZA)
• Commodity producers (XOP, GDX, XLE)
• Industrials (EXI)
• Financials (XLF)

Investopedia


You can also take advantage of currency moves by investing in:

• Stronger foreign currencies
• You can invest directly in the currency, currency baskets or in exchange-traded funds (ETFs).
• Stock market indexes or sovereign wealth funds of countries with appreciating currencies
• In the foreign companies or US multinational companies that derive the majority of their revenues from outside the U.S.^[18]
• If you are a non-U.S. investor, you can buy assets in the U.S., especially tangible assets, such as real estate.
• In commodities or companies that support or participate in commodity exploration, production or transportation
• For example, HFI longs OIH^[4]

References

1. DEEP CYCLICAL INVESTING: GETTING IT RIGHT
2. How to Think About Hedging Against Inflation
3. Profiting From A Weak U.S. Dollar
4. The Fall In USD Is Just The Start Of A Multiyear Downtrend And The Start Of A Multiyear Uptrend In Commodities
5. Commodity Prices And Currency Movements
6. TIPS Demand at 13-Year High Shows Inflation Expectations Ramping Up
7. How to Think About Hedging Against Inflation
8. Dollar Reaches Multi-Year Lows as Central Banks Shift Reserves Into Yuan
9. How to Profit From the 2018 Dollar Crash
10. Sector Rotation Analysis
11. Ready. Set. Get Prepared for Inflation!
12. Global Economic Perspective: January (Franklin Templeton Investments)
• Synchronized Global Expansion Continues, with Signs of Increased Demand for Commodities
13. Quarterly market update: Q1 2018 (Fidelity)
14. Rising Mortgage Rates and Housing Bubble 2.0
15. Dramatic Tax Changes Coming Your Way - Here's What You Need to Know
16. Interest rates are on the rise globally (Capital Group)
17. Ross Kay TheWeathyHomeOwner.ca on Canadian Housing
18. Dollar's Drop Has Big Impact On Stocks
• Given the dollar’s steep drop, you would expect to see the “international” basket do much better than the “domestic” basket, and that is exactly how things have played out.
• If the dollar puts in a bottom, though, you should see pretty dramatic rotation back into the “domestic” stocks.
19. U.S. Dollar Index - A Contradictory View - Major Inflection Point
• The alternating 15.6-year cycle is composed of a near-centrally translated 7.8-year interval from peak-to-trough-to-peak etc.
20. What Is The Bond Market Trying To Say?
• Market participants seem to be saying that there is no place for the Trump administration tax cuts and proposed infrastructure spending to go except into inflation and higher deficits.
21. Pending Home Sales Tick Up 0.5 Percent in December
22. U.S. Dollar Bear Market: 3 Reasons It Can Continue
23. As USD liquidity remains abundant, dollar bear market to continue
24. The U.S. Deficits And The U.S. Dollar: Bringing In A New Era?
• As explained by Hans Redeker, a strategist at Morgan Stanley, in the current situation: "The booming global economy and rising capital demand mean the US will face stiffer international competition for capital to finance the deficit, which means it will have to offer higher rates or a cheaper exchange rate, both of which we have seen this year."
25. Commodities: It's The Year Of The Bull
26. Eric Basmajian Positions For 2022: Tightening Into A Slowdown
• When economic growth declines, the US dollar rises.  As the largest economy, the US economic cycle dominates the global economic cycle.  When US economic growth is decelerating, generally, global economic growth is decelerating.  When global growth is decelerating, there's less demand for commodities and manufacturing. Australia and Canada, two major economies, are highly sensitive to the global commodity cycle, which follows global growth
27. Dollars, Eurodollars, and Leverage
28. Dollar’s Busted Bull Run Has Bears Calling End of an Era (Bloomberg)

Enya—Remember Your Smile

Video 1.  Remember Your Smile (YouTube link)

Lost in the mountains

far from the crowds

we would wander together

walking for miles

with night still before us

and day passing by

I always remember your smile

Cool in the evening

warm in the sun

the clouds moving slowly

time was undone

yet the days fell before us

and nights rolled on by

I always remember your smile

Every step and each moment

were all so worthwhile

I always remember your smile

I always remember your smile

And it's strange how for a moment

the heavens were mine

I always remember your smile

Each one has a journey

that's how it goes

sometimes we're together

sometimes alone

Susan Boyle - All I Ask Of You

Lyrics

(Donny)
No more talk of darkness,
Forget these wide-eyed fears;
I'm here, nothing can harm you,
My words will warm and calm you.

Let me be your freedom,
Let daylight dry your tears;
I'm here, with you, beside you,
To guard you and to guide you.

(Susan)
Say you love me every waking moment,
Turn my head with talk of summertime.
Say you need me with you now and always;
Promise me that all you say is true,
That's all I ask of you.

(Donny)
Let me be your shelter,
Let me be your light;
You're safe, no one will find you,
Your fears are far behind you.

(Susan)
All I want is freedom,
A world with no more night;
And you, always beside me,
To hold me and to hide me.

(Donny)
Then say you'll share with me one love, one lifetime;
Let me lead you to your solitude.
Say you need me with you here, beside you,
Anywhere you go, let me go too,
That's all I ask of you

(Susan)
Say you'll share with me one love, one lifetime;
Say the word and I will follow you.

(Donny & Susan)
Say you'll share with me each night each moment.

(Susan)
Say you love me!

(Donny)
You know I do.

(Donny & Susan)
Love me, that's all I ask of you.

Anywhere you go, let me go too,
Love me, that's all I ask of you.

Bertrend Russell—What I have lived for?

Three passions, simple but overwhelmingly strong, have governed my life: 

1. Longing for love, 

1. Search for knowledge, and 

1. Unbearable pity for the suffering of mankind

I have sought love, first, because it brings ecstasy — ecstasy so great that I would have sacrificed all the rest of life for a few hours of this joy. I have sought it, next, because it relieves loneliness — that terrible loneliness in which one shivering consciousness looks over the rim of the world into cold unfathomable lifeless abyss. I have sought it, finally, because in the union of love I have seen, in a mystic miniature, the prefiguring vision of the heaven that saints and poets have imagined. This is what I sought, and though it might seem too good for human life, this is what — at last — I have found. 

With equal passion I have sought knowledge. I have wished to understand the hearts of men, I have wished to know why the stars shine. And I have tried to apprehend the Pythagorean power by which number holds away above the flux. A little of this, but not much, I have achieved. 

Love and knowledge, so far as they were possible, led upward toward the heavens. But always pity brought me back to earth. 

Echoes of cries of pain reverberated in my heart. Children in famine, victims tortured by oppressors, helpless old people a hated burden to their sons, and the whole world of loneliness, poverty, and pain make a mockery of what human life should be. I long to alleviate the evil, but I cannot, and I too suffer.

This has been my life. I have found it worth living, and I would gladly live it again if the chance were offered to me.

These passions, like great winds, have blown me hither and thither, in a wayward course, over a deep ocean of anguish, reaching to the verge of despair.