Numbers That Matter: Housing market still under stress, constraining growth for plastics

You have likely heard this quote before. Keynes is believed to have said this in the 1930s when he was trying to describe the futility of attempting to time the highs and lows in the stock market.

This idea has stood the test of time, and I have found this concept to be useful not only when applied to the financial markets but also when trying to forecast the highs and lows in the U.S. economy and the industrial sector.

The stock market was indeed beginning to look a bit irrational as we started the second half of 2024, but history has taught me the stock market tends to correct itself regardless of my opinion. Nevertheless, there are some other trends or risks in the overall economy that have me concerned at the present time because they do not appear to be self-correcting.

Just to be clear, I am quite bullish about the long-term prospects for the overall U.S. economy. But I have never been able to believe that every segment of the economy is always behaving rationally. There are always risks.

One trend that has me concerned is the persistent problem with the U.S. housing market — talk about remaining irrational for a long time. Underlying demand for housing is robust, but the residential construction sector just cannot seem to get going.

The total number of houses started in the second quarter of this year declined by 7 percent when compared with the total from last year. For obvious seasonal reasons, the second quarter is the most important quarter of the year for the residential construction sector, and the performance so far this year does not bode well for the second half of 2024.

At the start of the year, I was optimistic this might be the year when residential construction starts to get its groove back. But my optimism is fading, and that has me wondering whether there might be other underlying risks to my outlook.

For most of the past decade, the U.S. economy expanded, interest rates were low and employment levels were strong. The pandemic was a major disruption to this scenario, but most segments of the economy are rebounding, especially the segments where there is strong pent-up demand. But the housing market just has not found a way to supply enough houses to meet this demand. This has pushed house prices out of reach for many potential buyers.

The trend in housing starts has traditionally been a reliable leading indicator of future economic growth. If it was an auspicious time to build a new house, then it was also a prosperous time for most other segments of the economy, especially the plastics industry. Currently, the housing market is under stress, and this is a serious constraint on the near-term outlook for many plastics products.

I am also concerned about the irrationality at the present time in the market for U.S. Treasurys. Fluctuations in the big stock indexes grab all the headlines, but the enormous market for bonds has the greatest effect on long-term economic growth and also demand for manufactured goods.

As of July 7, the yield curve for U.S. Treasurys had been inverted for two full years. Specifically stated, the 10-year Treasury note constant maturity minus the two-year Treasury Bill constant maturity is negative, and it has been negative for more than 500 days. This is an all-time record, and the curve shows no signs of normalizing anytime soon.

In other words, the market is making the government pay more to borrow money for two years than it is requiring for a loan of 10 years. From a risk standpoint, this is irrational to me. It seems much harder to calculate and manage the possible risks 10 years from now than two years, especially given the latest trends in the underlying economic data.

That is why economists have long believed an inverted curve signals a pending recession. The only time a rational market would rather own long-term debt rather than short-term debt is when the short-term outlook is particularly bad. Nevertheless, the curve remains persistently inverted.

As Keynes advised, I am not going to argue with the market. But I am increasingly concerned about this. Something is amiss, and I cannot get comfortable with the idea that the version of risk assessment currently represented by the inverted yield curve is some new kind of normal just because it has gone on for such a long time.

And this brings me to the final trend that makes me extremely ill at ease. This trend is not only highly irrational but also unsustainable. That is the trend in the federal budget deficit.

One look at the graph should send a shudder down anybody's spine, and there is little I can add to the debate about this that has not already been discussed in great volume and with extremely rational eloquence.

But I will offer a few observations. First, the past few years have witnessed the largest federal deficits by far during years in which there was full employment in the U.S. I can understand the rationale for greater government spending during times of an economic recession, but the deficit levels of the past few years are unnecessarily reckless.

Second, I believe this level of deficit spending by the federal government is the main reason the stock market is currently so expensive. They are borrowing massive amounts of money and then pumping it back into the system. Everybody is excited about artificial intelligence, but excess liquidity is what is really propping up the market. The debt the government keeps selling to finance the deficit is undoubtedly crowding out investment in other sectors of the economy, but the real danger here is that this is a vicious cycle that will come to an abrupt halt if the market curbs its appetite for government securities.

Finally, we are in an election year, and I have not heard either of the major political parties addressing the risks associated with this level of deficit spending. If anything, both sides appear willing to push the deficit even higher.

Therefore, I do not know how much longer this irrational trend will continue. But allowing it to continue longer than the government remains solvent is a risk all Americans — both Democrats and Republicans — should want to avoid.