Weak Housing Market - Small Caps Underperform

On Tuesday, the stock market took a slight breather as the S&P 500 fell 8 basis points, the Nasdaq fell 7 basis points, and the Russell 2000 fell 0.71%. The VIX rose for the 2nd straight day as it increased by 2.15% to 15.17. Maybe the spike on Monday was a sign correction is coming. There certainly isn’t much reason for stocks to rally from here as the economic data that came out Tuesday wasn’t good.

Weak Housing Market - Weak Home Depot Earnings

Home Depot missed earnings and revenue guidance which is in line with the weak housing data in Q4 2018. EPS was $2.09 which missed estimates by 7 cents. Revenues were $26.49 billion which missed estimates by $80 million. Same-store sales growth was 3.2% which missed estimates for 4.5% growth. Home Depot stock fell about 3% in the morning, but it recovered during the trading session as it only fell 0.91% on the day.

The warm December hurt sales by 0.85%. Usually, I don’t like when firms use the weather as an excuse for poor results. However, the weather isn’t an excuse for the poor 2019 guidance. The firm expects EPS to be $10.03 which missed estimates by 23 cents. Revenue guidance calls for 3.3% growth which is much less than last year’s 7.2% growth.

The good news for shareholders is the firm boosted its dividend by 32% and announced a new $15 billion buyback. This report signals the housing market is weak. This is exactly in line with the housing reports that came out Tuesday as housing starts, the S&P CoreLogic Case-Shiller home price index, and the FHFA house price index all missed estimates.

Weak Housing Market - Housing Starts

Housing starts missed estimates sharply as they were 1.078 million on a seasonally adjusted basis in December which missed estimates for 1.26 million. This was much below the low end of the expected range which was 1.2 million. Housing starts missed estimates by the most in 12 years. The November report was revised lower from 1.256 million to 1.214 million. This report supports the consistent theme that the housing market was terrible in December. Thankfully, about all the economic reports from December besides the Q4 GDP report have come out.

As you can see from the chart below, starts cratered while permits increased. November permits were revised lower from 1.328 million to 1.322 million. The December report beat estimates for 1.29 million as it came in at 1.326 million. That beat the high end of the estimate range which was 1.305 million.

(Click on image to enlarge)

The housing market is going to be a major drag on the Q4 GDP growth as real residential investment growth could be negative. The Q4 GDP report is set to come out on Thursday after being delayed for a few weeks because of the government shutdown. The consensus is for 2.2% GDP growth.

The Atlanta Fed GDP Nowcast lowered its estimate from 1.9% to 1.8% because of the housing starts report. The estimate for real residential investment growth fell from -4.4% to -5.8%. The first Nowcast for Q1 growth will be out on Friday. Unlike every other quarter which starts out with a ridiculous reading based on soft data reports, this one will have a lot more to work with as some hard data from January has been released.

Weak Housing Market - Housing starts were down 11.2%, exiting the 1.2 million to 1.3 million range.

It was the weakest report since September 2016. Wildfires hurt the West’s housing starts as they fell 26.3% monthly to 216,000. However, the other regions were also weak even without any wildfire issues. Starts fell 13.2% in the Midwest to 125,000. They fell 6% in the South to 630,000. They were flat in the Northeast at 107,000.

Single-family home starts fell 6.7% and multi-family starts fell 20.4%. This limits the decline in residential construction spending because single-family starts cost much more per unit. Permits were up 0.3% monthly. Single-family permits fell 2.2% to 829,000 and multifamily permits were up 4.9% to 497,000. Permits in the West were up 17.1% to 383,000. Strong permits signal the housing market will rebound in Q1. Even though housing starts were terrible, permits give me hope that my thesis that the housing market will be strong in the spring will be accurate.

Weak Housing Market - Yield Curve Flattens

Even though no rate hikes are expected for the rest of the cycle and the Fed funds rate is expected to be at about 2.12% by mid-2021, the yield curve has been flattening. The difference between the 10-year yield and the 2-year yield is still 16 basis points. However, the chart below shows the difference between the 10-year yield and the 3-month yield is only 19.4 basis points which is near the lowest point of the cycle.

The 10-year yield is at 2.64% which is only 9 basis points away from the year to date low on January 3rd. It is sharply down from the peak of 3.24% in November. That November level made no sense because inflation and growth were both falling. I stated the 10-year yield didn’t belong above 3% and I was correct after being wrong for a few weeks. I don’t see the 10-year yield increase in the near term because the leading indicators are still weak.

(Click on image to enlarge)

Weak Housing Market - Conclusion

The housing market was a disaster in November and December as the decline in rates didn’t help sales yet. We keep getting data on that period because the housing reports were delayed. This weakness will be highlighted in the Q4 GDP report. Finally, after Thursday we can move on from this terrible period and look at housing data from 2019 which will probably show improvements. Clearly, the stock market has moved on from Q4 2018 as it has rallied swiftly this year. While the housing market probably will pick up in the spring, the stock market is likely overbought. Investors’ principle worries should be the flattening yield curve and the weakening leading indicators.