When assessing the health of a major economy, we will look at the major drivers of activity. This would include things like employment, consumer spending on discretionary items (like vehicles) and the state of the housing market. In each of these categories, we have watched the U.S. economy shift from exceptionalism to fatigue. On Monday, the Department of Commerce reported that retail sales fell 0.9% in the month of May – two tenths of a point weaker than what the street predicted. Excluding autos, sales fell 0.3% and that was a more significant surprise given that the consensus call was for a small gain of 0.1%. Industrial production last month was also down 0.2% and manufacturing output fell for a second straight time.

 

These definitely don’t point to the booming economy President Trump wants and needs, but the real shock was Wednesday’s release of May housing starts, showing a drop of 9.8% to the worst level since the pandemic. After months of cautious optimism, the U.S. housing market just slammed the brakes — and took the economic narrative with it.

 

While economists had anticipated a decline in the number of shovels going into the ground last month, no one forecasted the magnitude of the drop we saw, as you can see in the above chart. Building permits also fell in May, albeit by a more modest 2.2% but that was on top of a 4% retreat in April. Housing completions showed a gain in May, but this is a lagging indicator and simply reflects projects started before we entered the wild, wild world of trumpnonomics.

 

Supply Pressures

It's not that there haven’t been clues that America’s housing sector was under pressure.  The National Association of Home Builders constructs a measure of builder sentiment, referred to as the NAHB/Wells Fargo Housing Market Index (HMI).  I show this index in the chart above, going back over the last ten years. This month, the HMI fell a further two points to 32 and this was the lowest since the 31 read back in December 2022 and only two points above the pandemic low.  In contrast to the obvious reasons behind the deterioration in those periods, the current situation belongs entirely to the policy tornado coming out of the White House. 

 

Tariffs are at the top of the list, especially with respect to lumber imports from Canada. Carney and Trump indicated at the G7 summit that a trade deal was likely in 30 days, there is still a 14.5% tariff on softwood lumber and the NAHB has warned that this rate could go higher over the course of this year. That has a larger impact on single residential home construction, but the bulk of the decline in starts in May was in multi-unit dwellings. For this segment, aluminum and steel prices have a disproportionately bigger bite and here we saw a 25% tariff in April get doubled at the start of this month.

 

The NAHB has also cited labour shortages as a factor behind lower builder sentiment – something that has been readily apparent in the data.  In the above chart, we are looking at the level of private payrolls in the U.S. construction industry and, as you can see, a gradual uptrend in employment has continued through the first half of this year. That doesn’t mean it hasn’t been tough to find new workers, but it is not reflective of a contraction in building activity. So, what is happening? For that we have to look at the segment of the workforce that doesn’t fully show up in the statistics and that is the number of migrant participants. This group has been pressured by the administration and the rise in deportation measures.

 

But How is Demand Holding Up?

The supply factors behind the cooling off in housing are indeed significant, but buyers are also not lining up around the block to buy homes. As the above chart shows, existing home sales have been languishing not far above the lows reached after the sharp increase in rates back in 2022-23 and nothing has emerged to stimulate demand.  Consumer confidence has slid in recent months, not only in response to the uncertainty created by Trump’s policies, but because of observable signs of weaker activity. 

 

The labour force isn’t falling apart, but it is moderating. Last month, there was a smaller gain in non-farm payrolls, but we aren’t seeing monthly declines and the unemployment rate held steady at 4.2%. That doesn’t mean it will stay that way.  In the chart below, there has been an uptrend in initial jobless claims and, while the number of initial claims dipped last week, the 4-week moving average rose to the highest level (245.5K) since August 2023. If this move continues in the coming weeks, that ‘stable’ unemployment rate could get more unhinged than Trump at a mean press conference.

 

 

Demand is also being crimped by higher borrowing costs.  Even though the Federal Reserve left rates unchanged this week, mortgage rates are influenced more by what is happening at the longer end of the yield curve and, as I discussed a couple of weeks ago, this is area is being pressured by fiscal concerns, rising inflation expectations and a weakening in the U.S. dollar. Unlike Canada, where a ‘long-term’ mortgage rate is 5 years, you can get a 30-year contract south of the border.  The most common mortgage option is the 30-year fixed-rate mortgage (FRM) loan, where you contract to pay that same rate over 30 years.  The chart below maps this rate against the 10-year U.S. treasury yield.

 

Back in the pandemic, this rate fell to below 3%, only to skyrocket to 7% and then close to 8% in the aftermath of the once in 50 years bond correction of 2022. Things cooled off and before last year’s election, the 30-year moved back towards 6%. We are now back in the 7% region and if we see the long end of the curve sell off as it did just months ago, we will be through this level. And that could potentially worsen an already troubling trend with respect to mortgage delinquencies. 

 

Back during the Great Financial Crisis, close to 14% of fixed-rate mortgages in the U.S. went delinquent. This means that a borrower missed a scheduled payment.  In the chart below, we look at the delinquency rate or the percentage of fixed rate mortgages that went delinquent and as catastrophic as that period was, the recovery in the economy and jobs quickly skated homeowners back onside, to the point where delinquencies represented only 6% right before the pandemic. They then spiked above 14% and fell back as rates were cut. Since 2022, delinquencies have been creeping higher again and if employment conditions weaken, the trajectory could steepen.

 

Another indication of the fade in housing demand is how builders are responding on price. Given the onslaught of Trump 2.0 tariffs, the immediate assumption was that costs would be passed down to the consumer causing perhaps a transitory rise in inflation. This might be the case for general consumer goods, but it isn’t showing up in the U.S. housing sector. The latest HMI survey also revealed that 37% of builders reported cutting prices in June, the highest percentage since NAHB began tracking this figure on a monthly basis in 2022. This compares with 34% of builders who reported cutting prices in May and 29% in April. Meanwhile, the average price reduction was 5% in June, the same as it’s been every month since last November. The use of sales incentives was 62% in June, up one percentage point from May.

 

Portfolio Implications

It is premature to say that the U.S. is on the verge of another major housing correction – one that can take out some of the legs of its economic stool. If recent indications do in fact portend such an outcome, it is worthwhile to examine one’s portfolio today and see if there are any companies that are particularly vulnerable. The list begins with the obvious ones, such as producers of building materials, but it also encompasses real estate and finance.

 

Call it premonition, but most of Canada’s lumber stocks were pricing in bad times before Trump’s liberation day. As you can see from the above chart, Canfor Corp and West Fraser have tumbled from lofty levels around the time of the U.S. election and while we have seen consolidation during the past couple of months (sell the rumour, hold the fact), this was before the latest set of housing data. I added Stella-Jones to the mix as it is at a bit of a crossroads. On the one hand, it does derive about 75% of its revenue from the U.S. and has exposure to residential construction and the renovations sector. Yet, as one of the leading producers of pressure-treated wood products, it is going to be busy with respect to the port infrastructure initiatives taken in Canada and the U.S.

 

Lest we forget, U.S. banks didn’t have a lot of joy during the last episode of housing market stress. The topic of losses on the mortgage book isn’t being broached much these days, as earnings remain decent among the larger names. What happens on the regional side of things could be different. The above chart shows the S&P500 regional bank index, and we are already seeing the post-April rebound fading this month.  It’s hard to believe that it was only two years ago that this segment had the proverbial rug pulled out thanks to a double-digit correction in long-term fixed income assets and a repeat move is unlikely. That doesn’t mean there isn’t more downside and the potential for stop-loss triggering on a breach of the April lows wouldn’t be pretty.

 

Counter Argument Please

It’s entirely possible that the U.S. housing market doesn’t go in the tank and we don’t re-live memories of 17 years ago. For sure, the household debt situation is in a much better place than then.  Wish we could say the same for Washington. However, if construction is derailed for too long then we could flip the pendulum the other way and end up with excess demand and higher home prices. Yes, we do remember the last time this played out. FOMC members are still forecasting two rate cuts before the end of this year, which would be an offset, but with inflation expectations already elevated a return transmission effect through owner equivalent rent from higher home prices isn’t going to get you more rate cuts than what is being priced in.

 

The best devil’s advocate proposition is that the tariff tirade goes away. The big beautiful bill is morphed into a more sensible fiscal plan that allows for some fiscal stimulus without wrecking the bond market and that the Fed delivers on moderate easing. This would certainly lift the veil of uncertainty hanging over the U.S. housing market, builders would get spades in the ground and cranes in the air and a vital component of the economy would return to the plus column. Yes, that would give us a recovery, but even the most optimistic builder wouldn’t bet the house on it just yet.

 

 On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.

Andrew Pyle

 

 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.

Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc. Clients are advised to seek advice regarding their circumstances from their personal tax and legal advisors. This commentary is for informational purposes only and is not being provided in the context of an offering of any security, sector, or financial instrument, and is not a recommendation or solicitation to buy, hold or sell any security.

 

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