Housing Boom to Continue
First Trust Economics - April 12, 2021
Housing prices have soared in the past year. The national Case-Shiller index is up 11.2% in the past twelve months, the largest gain since 2005-06. The FHFA index is up 12.0% in the past twelve months, the largest on record (going back to 1991).
Given these gains, some are wondering whether housing is back in a 2000s-type bubble. But a deep dive into the data suggests we are not.
To assess home prices we use the market value of all owneroccupied homes calculated by the Federal Reserve. We then compare that to the “imputed” rent calculated by the Commerce Department for the GDP report. (Imputed rent means what people would pay to rent their homes if they rented them from someone else.) In the past 40 years, home values have typically been 16.4 times annual rent. At the peak of the bubble in 2005, they were 21.4 times annual rent, or 33% above normal. Now, home prices are 17.8 times annual rent, about 11% above normal.
We also compare home prices to the Fed’s measure of replacement cost. In the past 40 years, home prices have typically been 1.59 times replacement cost. In 2005, they peaked at 1.94 times replacement cost, a premium of 22.5%. Now homes are selling for 1.63 times replacement cost, only 2.5% above normal, which is minimal.
Does this mean housing is at risk? We don’t think so. The recent price surge is based on fundamentals and the housing market should continue to boom.
The primary problem is a lack of homes. Based on population growth and scrappage (voluntary knockdowns, fires, floods, hurricanes, tornadoes…etc.), we would normally expect housing starts of 1.5 million per year. But in the past twenty years (March 2001 through February 2021), builders have only started 1.256 million per year. Builders haven’t started more than 1.5 million homes in a calendar year since 2006.
No wonder the inventory of homes for sale is so low! Single-family existing home inventories are at rock bottom levels, with only 870,000 for sale in February. To put this in perspective, the lowest inventory for any February on record from 1982 through 2016 was 1.55 million. Meanwhile, there are only 40,000 completed new homes for sale, versus 77,000 a year ago and an average of 87,000 in the past twenty years.
Two other factors are likely at work. One issue is that there’s a moratorium on evictions, so some tenants are paying less in rent than they normally would, which is temporarily holding down rental values versus home prices (therefore elevating the price-to-rent ratio). This is also holding down the housing component of the Consumer Price Index, which is calculated using rents, not home prices.
Another factor is that people have moved away from places where renting is popular to places where home ownership is popular. If you leave New York City or San Francisco for Nashville or Boise, there’s a good chance you went from renting to owning. This helps boost home prices as well.
Yes, home prices are up and, yes, they look somewhat expensive relative to normal, but this is more about the unprecedented events of the past decade, not some problem with the market. With the Fed so easy, and the stock of housing constrained, prices will continue to rise. The housing boom will continue.
Tax Hikes Are Coming
First Trust Economics – March 29, 2021
The federal budget deficit hit an all-time record high of $3.1 trillion last year. With the passage of the recent blowout "stimulus" bill, it's set to be even higher in 2021. Now we watch and wait for a potential infrastructure bill, which could run as much as an extra $4 trillion over the next ten years. A trillion here, a trillion there...you know how the old saying goes.
As night follows day, higher spending – unless offset with future spending cuts – is going to lead to higher taxes. That's certainly the course the Biden Administration looks set to follow.
So far, consistent with his campaign pledge, President Biden says he's not going to raise taxes on people making less than $400,000 per year. But that's not where the money is.
Let's say they raise the top personal tax rate of 37% back to 39.6%, which is where it was for eight years under President Clinton, the last four years under President Obama, and the first year of President Trump. That change would generate only an additional $20 billion in extra revenue per year, based on 2018 tax data. If they also raised the 35% income tax bracket to 39.6%, that would raise an extra $13 billion per year. And this year the 35% tax rate kicks in at $209,426 for singles and $418,851 for married couples, which means that path would violate the $400,000 promise. Either way, it's like trying to fill a swimming pool using a teaspoon.
If they were to go for broke and raise both the 35% and the 37% brackets to a 100% tax rate, and people keep working and paying everything they made in taxes, that would have raised about $681 billion in 2018. Big money, but still not close to bridging the budget gap.
That's why we think Transportation Secretary Pete Buttigieg's trial balloon about taxing auto mileage has to be taken seriously. The big spenders in Washington, DC know that tapping into the incomes of people making less than $400,000 per year is necessary to pay for all their spending promises.
At this point, we think it'd be very tough to get to 50 Senate votes for a whole new federal tax system on mileage. The same goes for a Senator Elizabeth Warren-style wealth tax, which is also of dubious Constitutionality. And, unless they get rid of the filibuster, the same goes for applying the Social Security tax to wages and salaries above $400,000.
Instead, we think the tax hike, which will likely be implemented on January 1, 2022, includes the following parts:
1. A top rate back up to 39.6%
2. A corporate rate, now 21%, close to 28%.
3. A top rate on capital gains and dividends at about 24% versus the current 20%
4. A lower exemption for the estate tax.
The one thing we can say for sure about all this is that some of these projections will be wrong. But we think most of it'll be right. The Biden team has suggested getting rid of the step-up basis at death for capital assets, but we think that would be an administrative nightmare. Moderate Senators would listen to horror stories about trying to adjust the basis for small farms and business owners and say, no.
The Biden team has also supported applying the 39.6% tax rate to the capital gains and dividends of the highest earners. That's one proposal that, if enacted, could hurt the stock market and the wider economy. The long-term capital gains tax rate hasn't been that high since the late 1970s; the dividends rate since 2001. Raising them both that high at the same time? If you haven't already decided that all this spending is damaging to long-term growth and investments, this would certainly be worrisome. We see a rise to 24% as the compromise that gets the votes.
Bargaining on tax hikes has already started in Washington, at least behind the scenes. It's going to be a long process, but we can say with high conviction that taxes are going up.
Brian S. Wesbury - Chief Economist
Robert Stein, CFA – Deputy Chief Economist
Inflation and The Fed
First Trust Economics - March 15, 2021
We believe inflation is still, and always will be, a monetary phenomenon. It is defined as “too much money chasing too few goods and services” – but that doesn’t mean every period of higher inflation is going to look exactly the same.
Today’s case for higher inflation is easy to understand. The M2 measure of the money supply is up about 25% from a year ago, the fastest year-to-year growth in the post-World War II era. And while measures of overall economic activity such as real GDP and industrial production are still down from a year ago (pre-COVID), Americans’ disposable incomes are substantially higher, boosted by massive payments from the federal government with more “stimulus” on the way.
Right now, the consumer price index is up only 1.7% from a year ago. But, this year-ago comparison is set to soar to 2.5%, or higher, as we drop off the big declines in prices we saw during February - April 2020. The extent of this increase will likely be held back by the government’s measure of housing inflation (which only focuses on rental values, not home prices). Excluding rents, inflation will be more like 3.0% this year, and will likely move up by about another percentage point in 2022.
Producer prices are already up 2.8% from a year ago, with much faster growth in prices further up the production pipeline. Does this mean we are heading back to double-digit inflation, bell-bottoms, disco balls, and the return of Jimmy Carter-style stagflation?
We think we are a long way from that. As Mark Twain once said, “History doesn’t repeat, but it often rhymes.” In the 1970s, if the Fed would have fought inflation harder early on, we would have never seen it hit double-digits. As a result, for now, we are thinking more of the late 1980s, not the 1970s.
Consumer prices rose only 1.1% in 1986 as oil prices collapsed, but then it revived in 1987, rising above 4.0% by late Summer. To fight this rise in inflation, the Fed raised short-term interest rates by about 140 basis points, to about 7.3% from 5.9% towards the end of 1986.
As the 10-year bond yield rose in 1987, the stock market took it on the chin and crashed in October. Alan Greenspan responded by providing as much liquidity as needed to restore confidence in the financial markets, and had the Fed cut shortterm rates through early 1988. The money supply didn’t soar, but short-term interest rates were lower than the trend in nominal GDP growth (real GDP growth plus inflation), signaling loose monetary policy.
Once the smoke cleared from the stock market crash, the Fed found itself behind in the inflation-fight. Inflation jumped to 5.4% in 1989, before Iraq invaded Kuwait, and then higher oil prices from the war pushed it to 6.3% after the invasion. As a result, the Fed eventually lifted short-term rates to almost 10.0% to get inflation under control. The result was the tight-money-induced recession of 1990-91, which some still wrongly blame on the Iraqi invasion.
We don’t know if the late-1980s pattern is the one we’re about to follow. What we do know is that just like with the stock market crash of 1987, the Fed has demoted inflation as its top concern and pushed COVID recovery to the top of its list. Letting M2 growth rise to 25%, and holding rates at basically zero, in spite of an economic recovery, is the proof.
The biggest question is how quickly the Fed turns its attention to inflation as it builds and how far will they go to fight it. In the 1970s, it was double-digit inflation, in the 1980s, it was 5% to 6% inflation. Either way, this Fed has made it clear that it will remain easy through 2022.
As are result, we remain bullish on the economy and stocks, but cautious on bonds as inflation picks up. We all need to wait until 2023 to see what history we rhyme.