Expect slow growth in US housing market in 2019

The good news is the U.S. Census Bureau is steadily recovering from the effects of the shutdown. The bad news is its latest data shows the number of houses started in the United States in December fell to 71,700 units.

This was a 12 percent drop when compared with the same month in 2017. When combined with the revised figures from October and November, the fourth-quarter total for 2018 was down a disappointing 6.7 percent.

This fourth-quarter performance put a sour ending on an otherwise solid year. Through the first three quarters of 2018, the trend in the monthly data for U.S. housing starts was unequivocally upward. As of last September, the year-to-date starts total was up 7 percent when compared with 2017.

If you add the weak fourth quarter to the total from previous three strong quarters, the annual tally for housing starts in 2018 was just below 1.25 million units. This was a moderate gain of 3.6 percent over 2017, and it marked the ninth consecutive annual increase in the data.

My latest forecast calls for a small increase in the range of 0-2 percent in total housing starts in 2019. This will put the annual total at 1.27 million units. It may be a close call, but the string of annual gains should get to at least 10 years. Admittedly, my margin for error is a small one, therefore the risk in this forecast is a bit higher.

It's no secret that the trend in housing starts is one of the most closely watched macroeconomic indicators there is — and not just for the segment of the plastics industry that manufactures building materials. Since the end of World War II, the trend in this data has been a crucial leading indicator of Americans' overall spending and confidence levels.

In other words, if it's a good time to build a new house, then it is also a good time to buy, renovate or refurbish an existing home. It is also a good time to buy a new car or other big-ticket items. Expanding construction activity indicates that workers who have jobs and households are optimistic about their prospects for the future. Throughout the past century, one of the defining characteristics of the U.S. economy is that when Americans feel prosperous, they build houses. And on the flip side, when new residential construction activity starts to wane, it often signals a recession in the overall economy.

So it is no surprise that three consecutive monthly declines have the attention of analysts and policymakers. The question increasingly being asked is, is this recent downturn in housing starts the start of an extended downtrend that may even portend the next recession in the overall economy? After all, this recovery is already the longest one any of us has ever experienced.

And given the political tone in the country, the apprehensions stemming from the trade issues with China, the slowdown in global economic growth, and the uncertainty surrounding the Mueller report and sundry other legal issues of our president, this question has a greater sense of importance.

Nevertheless, I believe the probability of a sustained downturn at this time is unlikely. There is just too much momentum in the economic fundamentals. The labor market is too strong and the wage and income data are even starting to accelerate upward. Overall economic growth will decelerate this year, but it will stay firmly positive. The recent decline in housing starts should turn out to be a market correction caused by one-time events. We will likely now experience a period of consolidation followed by a reversion to the moderate uptrend in the data.

For seasonal reasons, the fourth quarter is always the weakest of the year for housing starts and the data for December of any given year can exhibit wide fluctuations due to weather. There were some significant weather issues in December 2018 that negatively affected the data, especially if you consider the incredible forest fires in California weather-related. There was also a shutdown of the federal government and a hotly contested increase in the Fed Funds Rate that pushed mortgage rates higher and resulted in a free-fall in the stock market. A downturn in the starts data is understandable, but I think the reaction was overdone.

I also believe the trend in the first three quarters of last year was likely too strong given the underlying economic fundamentals. The slope of the graph clearly jumped in the first half of 2018 when compared with the pace of the previous two years. After an unsustainable jump, a period of consolidation in the market is not uncommon. The negative turn in the data in the last quarter was unexpected, but it is not inexplicable, nor is it necessarily a harbinger of further deterioration in residential construction activity.

Looking at the longer-term fundamentals for the residential housing market, there are two persistent challenges: a shortage of skilled labor in many of the fastest-growing areas of the country and a problem with affordability due to a lack of supply. The labor shortage will remain a challenge for the foreseeable future, but the problem of affordability is gradually improving.

The latest statistics on home prices exhibit a clear trend of deceleration in price appreciation. Home prices are still rising but at a much slower rate than they have in recent years. Mortgage rates, which appeared to be in an uptrend at the end of last year, have recently stabilized. Meanwhile, the statistics on wages and household incomes are rising at an accelerating rate.

We may soon get to a point where wages are rising faster than home prices and this might be the inflection point that boosts residential construction activity. One indicator of this will be the trend in building permits, which, by the way, exhibited a nice jump in December. If this rise in the permits data persists, then it bodes well for the crucial spring season in the starts data.

From a longer-term perspective, the outlook is still good. There are no signs this sector is near overheating. The pre-crisis peak for this starts data posted in 2006 was almost 2.1 million units. We are not only still well below this peak, but there is some debate as to whether we have even reached the break-even level of new homes each year needed to replace houses lost as a result of disasters or obsolescence and to meet the demand of new household formations.