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July Industrial Production Report flat, disappointed homebuilders

Brent Nyitray, Sr Real Estate Analyst

Industrial production is a bellwether of economic activity

Industrial production is a good top-down macroeconomic indicator that helps forecast the labor market, final demand, consumption, and inflation. While manufacturing is no longer the primary driver of the U.S. economy, it still influences the economy to a large degree—particularly for unskilled workers. U.S. manufacturing has been undergoing a bit of a renaissance lately due to cheap energy prices. While there’s still a difference between wages overseas and here, low natural gas prices are offsetting that difference. Also, as wages rise overseas, the cheap labor arbitrage (taking advantage of lower wages) is fading away. The Fukushima nuclear disaster also showed how elongated supply chains are vulnerable.

(Read more: Bernanke’s comments send mortgage rates screaming higher)

Increases in industrial production generally signal increases in employment. Lower-skilled workers have struggled since the financial crisis, which has dampened aggregate demand and consumption. Things are finally starting to improve as construction jobs rebound and more companies are starting to move towards onshore production.

(Read more: Mortgage rates fall slightly)

Flat month as mining increases offset weak utility spending

Industrial production was flat in July after rising in June. June’s increase was the biggest since February. On a year-over-year basis, production rose 1.4% from a year earlier. Utilities fell, while mining rose. Utilities dropped because an unseasonably cold winter and spring have turned into an unseasonably cool start to summer. Overall, the report suggests that the global slowdown is flowing through to industrial production, but that the United States still remains in expansion.

(Read more: Real Estate Price Appreciation widely dispersed by location)

Implications for homebuilders

Homebuilders are highly sensitive to the economy. Any sort of slowdown can leave them with excess inventory, and if home prices don’t rise, builders are stuck with depreciating inventory that costs them to maintain and finance. They will look at the production numbers and conclude that the economy is still expanding moderately. If anything, increasing production portends an increase in hiring, which is definitely bullish (positive) for the economy.

Recovery in the homebuilding market will be driven primarily by first-time homebuyers. They’re still struggling to find jobs, and until we see employment growth back to normalcy, it may be difficult to see the 1.5 million housing starts that are typical of an expansion. We recently broke 1 million, which historically has been a very depressed level.

Homebuilders have experienced quite the renaissance over the past year, as the homebuilder ETF (XHB) has rallied. Rising real estate prices seem to be driving increases in orders. As the economy improves, renters will become more comfortable with the idea of homeownership. Given that the cost of renting is way higher than the cost of owning, marginal increases in the overall state of the economy and confidence will drive home demand. Specific homebuilder stocks that will be positively affected by changes in consumer sentiment include KB Home (KBH), Lennar (LEN), NVR Homes (NVR), Standard Pacific (SPF), and Toll Brothers (TOL).

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