In the second quarter, the decline in residential investment subtracted 0.7% from real GDP growth. The third quarter has started on a sour note: July housing starts dropped nearly 20% from their cyclical peak in April.
Home builder sentiment for August plunged to its lowest level since June 2014 (excluding the pandemic), raising concerns of a housing recession. This suggests further weakening in construction activity in the months ahead.
Also, the sharp drop in housing affordability suggests more downside. The cyclical slowdown in housing will likely push the broader economy in the same direction. Single-family home sales tend to lead retail sales by about six months. This suggests slower consumer spending growth for the rest of the year, one of the economy’s current pillars. Housing is pointing to a coming recession in the U.S.
This year has not exactly been the year of the 60/40 portfolio. No matter which way you cut it, 2022 has been the worst year in 50 years for stocks and bonds combined. Both stocks and bonds are down more than 10% YTD. Stock returns are measured by the S&P 500 and bonds by an “aggregate” bond benchmark. This benchmark includes both government and corporate bonds of different maturity lengths. If you are an equity investor, it has been hard to avoid damage this year; even conservative stocks are down. However, fixed-income investors could have limited bond price downside by staying with high-quality, short-term maturities.
NO MORE FED ‘PUT’
On Friday, Fed Chair Powell gave a short talk on how long it could take to tame inflation, and shares plunged. “We will keep at it until we’re confident the job is done” were among the words that spooked investors.
One thing is for sure: the dovishness that the market read into the July FOMC statement is nowhere to be seen, and stocks are trading without a safety net with the current policy. The Fed ‘put’ is a long way lower if it even exists anymore. (The Fed ‘put’ is the expectation by investors that the Fed will save the day and ease policy if the stock market plunges.)
While the Volcker shock isn’t likely to be repeated, the Fed’s recent rhetoric reflects a likely recession. And to complicate matters, as we mentioned last month, the economy is far more sensitive to interest rate changes than it was 40 years ago, owing to a debt load that has more than doubled. This increases the chance of recession even more.
In summary, Fed Chair Powell’s short speech made no mention of balancing inflation and employment. The speech was laser-focused on price stability. With plenty of signs the economy is softening, Powell’s shift in tone seems ill-timed.