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Shane Oliver, Head of Investment Strategy

& Chief Economist

The US housing sector


turning
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Olivers
Insights
Key points
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While its too early to call the end of the secular bear
Bullets
market in US shares, there are some signs of light in the US
economy, notably in manufacturing, energy production and
housing.

>

In particular, after triggering the global nancial crisis, the


US housing slump appears to be over and a recovery in
prospect.

>

This will help prolong the current US economic recovery,


boost household wealth and over time and add to global
commodity demand.

Introduction
Starting with the bursting of the technology bubble in 2000,
the fortunes of the US economy have waned. Since then, the
US has seen two recessions with the last being the worst since
the 1930s, a rising trend in unemployment, the bursting of a
corporate debt bubble with the tech wreck and the bursting of a
housing debt bubble with the sub-prime mortgage crisis. So its
little wonder the US share market has been spinning its wheels
in a secular bear market. Some commentators even talk of a
permanent decline for the US.
The high level of US public debt, ongoing private sector deleveraging,
less business friendly policies, demographic trends and the absence
of extreme share market undervaluation suggest the secular bear
market in US shares may not be over yet. That said, it would be
dangerous to write the US off. Many did this in the 1970s only
to see it roar back with a vengeance in the 1980s and 90s. More
importantly, there are some signs of light at the end of the tunnel for
the US in manufacturing, oil production and housing. This note takes
a look at these sectors, focusing on the latter as housing was the
original driver of the global nancial crisis.

US manufacturing renaissance
Recently there have been numerous examples of companies
setting up manufacturing plants or expanding production in
the US over locations in Canada, Mexico, Japan or the emerging
world. These include Maserati, Toyota, Honda, Nissan, Kia, Intel,
Whirlpool and Caterpillar. In fact for the rst time in over 35
years, annual growth in manufacturing employment is exceeding
employment growth elsewhere in the US economy. The key
drivers of Americas manufacturing renaissance are restrained
unit labour costs in manufacturing (which have been unchanged
for the past 30 years), rising wages in emerging countries, the
low US dollar (US$) after a decade long slump, and cheap energy
prices helped by surging natural gas supply. While its early days
yet, Americas manufacturing renaissance has further to go.

Surging oil production


US natural gas supply has been surging for years resulting in
low prices. More signicantly, a few years ago US oil production

EDITION 9 16 MARCH 2012

quietly bottomed and is now on the rise again thanks to a surge


in shale oil production. The US has huge reserves of shale oil
and advances in fracking technology (by which shale kilometres
below the surface is fractured using explosives, allowing oil to be
released and ow to the surface) and oil prices around US$100
per barrel are making it economic for these reserves to be tapped.
Some even see the US becoming self sufcient in oil again in the
decades ahead.

US housing bottoming
A collapse in the US housing sector was at the core of the subprime mortgage crisis in the US which subsequently morphed
into the global nancial crisis. US house prices and housing
construction surged into the middle of the last decade as lax
lending standards underpinned a huge surge in home ownership.
Boom turned to bust, starting around 2006 as housing supply
started to surge and it became harder for sub-prime borrowers
to renance their loans. Foreclosures rose, made worse in turn
by rising unemployment as the whole process fed on itself. The
subsequent slump has seen a 34% plunge in house prices. This
has seen the volume of private residential investment collapse
by about 60% from its peak in the mid 1990s, resulting in a huge
drag on US gross domestic product (GDP) growth.

Why the worst is likely over for US housing


There are good reasons to believe that the US housing market is
bottoming and starting to recover.
The rst thing to note is that most US housing indicators have
stabilised. Home sales have been bouncing along a bottom since
2009. Housing starts and permits to build new houses have been
bottoming since late 2009. Furthermore, the National Association
of Home Builders conditions index has now broken out on the
upside, pointing to a rise in starts ahead.
Home builders conditions point to stronger housing starts
2500

US Housing
Starts, '000
(LHS)

2000
1500
1000
500
0

National Assoc of Home Builders'


conditions index (RHS)
86

88

90

92

94

96

98

00

02

04

06

08

10

12

80
70
60
50
40
30
20
10
0

Source: Bloomberg, AMP Capital

Second, the number of vacant homes is now starting to fall


sharply. Over time the equilibrium number of vacant homes has
increased in line with the rising population. This is proxied by
the long-term trend line in the next chart. It can be seen that
the gap between the actual number of vacant homes and its
long-term trend is now closing rapidly. Related to this, household
formation is likely to rise sharply. Since 2006 it has been running
well below that implied by population growth and has collapsed
from a record 2 million to around 700,000 last year. This reects
tough economic conditions causing young people to stay at home
with their parents for longer and is likely to rebound as economic
conditions improve. If the number of vacant homes continues to
decline at the same rate as the last couple of years and household
formation picks up then the overhang of housing will likely be
gone by year end.

Similarly, house price to income and house price to rent ratios


have collapsed, pointing to good value in US housing.

The US inventory of vacant houses has almost fallen back


to its long-term trend
12000

Thousands

US house prices back to fair value or cheap

Total vacant
houses

10000

30
25
20
15
10
5
0
-5
-10
-15

8000
6000

Long-term trend

4000
2000

65

70

75

80

85

90

95

00

05

10

Source: US Census, AMP Capital

Third, the stock of unsold new homes has largely vanished. It is


now at its lowest level since the 1950s. This seems more extreme
when it is compared with the fact that the US population has
more than doubled since then.
The stock of unsold single family homes for sale has almost
vanished
600
550
500
450
400
350
300
250
200
150
100

70

75

80

85

90

95

00

05

10

1991

2003

2007

2011

The improvement in US house price valuation measures stands


in stark contrast to the still very overvalued Australian housing
marketbut thats a different story. Note both the US and
Australian charts use OECD data for consistency.

5
4

Delinquency rate, % (LHS)


03

04

05

06

07

08

09

10

1995

1999

Australian house price


to income ratio

2003

2007

2011

A recovery in US housing has several implications.


>

First, by reversing a signicant drag on the US economy


it should help perpetuate economic recovery.

>

Second, this is likely to be reinforced by a boost to US


household wealth as house prices stabilise and recover.

>

Third, residential construction is a key user of raw materials


like copper, therefore a recovery in US housing construction
should boost global commodity demand.

1
02

Australian house
price to rent ratio

What a recovery in US housing would mean?

% Dwellings in
foreclosure (RHS)

01

% deviation from long-term average

The bottom line is that the US housing market appears to have


bottomed with recovery in both activity and prices likely.

00

1999

Source: OECD, AMP Capital

Falling mortgage delinquencies point to falling foreclosures

99

1995

Source: OECD, AMP Capital

1991

Fourth, while the US mortgage foreclosure rate remains high,


the delinquency rate is slowing as are the number of new
foreclosures, pointing to a decline in foreclosures ahead.

98

US house price to
income ratio

60
50
40
30
20
10
0
-10
-20
-30

Source: Bloomberg, AMP Capital

11
10
9
8
7
6
5
4
3

US house price to
rent ratio

.... in stark contract to Australian housing which remains very


expensive

Thousands

65

% deviation from long-term average

11

Source: Mortgage Bankers Assoc of America, AMP Capital

Finally, housing affordability has reached a record level. While this has
not been acted upon given the excess supply of housing and tough
economic conditions, we are likely to see greater demand for houses
as the excess supply dwindles and economic conditions improve.
US housing affordability is at record high
200
180

Concluding comments
While the secular bear market in US shares that began 12 years
ago may have further to go, there are a number of positives
suggesting there is light at the end of the tunnel. In particular
the US housing sector appears to be bottoming.
Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital Investors

160
140
120
100
80
60

70

73

76

79

82

85

88

91

94

97

00

03

06

09

12

Source: Bloomberg, AMP Capital

Contact us

AMP Capitals International Client Services Team


at internationalCS@ampcapital.com

Important note: While every care has been taken in the preparation of this document,
AMP Capital Investors Limited (ABN 59 001 777 591) (AFSL 232497) makes no
representation or warranty as to the accuracy or completeness of any statement in it
including, without limitation, any forecasts. Past performance is not a reliable indicator
of future performance. This document has been prepared for the purpose of providing
general information, without taking account of any particular investors objectives,
nancial situation or needs. An investor should, before making any investment
decisions, consider the appropriateness of the information in this document, and
seek professional advice, having regard to the investors objectives, nancial situation
and needs. This document is solely for the use of the party to whom it is provided.

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