Home Price Appreciation Outstrips Wage Growth
A Stronger-Than-Expected May Jobs Report Sends Bonds Reeling
Employment and wages are most important
Aside from employment, the most important indicator of economic well-being is wages. Despite falling unemployment, one of the conundrums of the current labor market is flat real, or inflation-adjusted, wages. Over the past decade, wages have more or less kept pace with inflation, but they haven’t increased.
In fact, much of the increase in consumption during this period is due to asset price inflation, not wage inflation. Instead of getting a big raise, people took out a home equity line of credit and used that to fund consumption. That approach worked as long as house prices kept rising.
However, since the bubble burst, wages have had to fund consumption—and wages have been more or less flat. In the above chart, you can see how the slope of the line changes with the Great Recession in early 2009.
Highlights of the April jobs report
Average hourly earnings increased 0.3% month-over-month and 2.3% year-over-year to $24.96. Average weekly hours were flat at 34.5. The Fed is not going to worry about inflation until it sees wage growth. As of now, wage growth is barely outpacing inflation.
Once inflation starts again, you will see long-term rates—which you can trade via the iShares 20-year bond fund (TLT)—increase as well.
Implications for homebuilders
Historically, real estate prices have correlated tightly with wage growth. That relationship began to break down in the late 1990s as wages grew at the rate of inflation and real estate prices began posting double-digit gains. Recently, home prices have been increasing again, but that’s due to low inventory. If you use the median home price data from the National Association of Realtors, the median house price to median income ratio is again approaching bubble-type highs. As the Fed removes accommodation, further home price appreciation will be dependent on wage growth.
Virtually all the homebuilders have seen a deceleration in average sales prices. They’ve been content to keep a lean inventory and raise prices. That strategy seems to have been pushed as far as it can go. Now we’re starting to see builders like PulteGroup (PHM) and D.R. Horton (DHI) move into entry-level brands, which is more about pushing through volume than increasing prices. Builders like Lennar (LEN) have been reporting an increasing backlog, which bodes well for the supply going forward.
Investors interested in trading in the homebuilding sector can look at the S&P SPDR Homebuilder ETF (XHB).
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