US economic growth accelerated last month, according to the November update of the Chicago Fed National Activity Index. But while the broad trend is looking stronger these days, housing remains wobbly. Existing home sales fell a hefty 6.1% in November – the biggest monthly decline in over four years. The slide follows last week’s news of November’s sluggish growth in housing starts and a decline in newly issue building permits – a sign that housing construction may be headed lower in the months ahead. Considering the residential real estate’s influence in macro matters, it’s reasonable to wonder if the soft data of late pose a threat for an economy that’s otherwise expanding at a faster pace.
It’s widely recognized that housing’s a key factor for the nation’s economic activity. According to Ed Leamer’s study of the sector’s role through the decades, “Housing IS The Business Cycle.” Writing in 2007, he advised that “of the components of GDP, residential investment offers by far the best early warning sign of an oncoming recession. Since World War II we have had eight recessions preceded by substantial problems in housing and consumer durables.”
That’s an ominous track record, especially now, in the wake of recent numbers for the housing sector. Newly issued building permits, for instance, were flat on a year-over-year basis through last month. More troubling: the annual pace of permits has been winding lower for several years. Taken at face value, this leading indicator for the housing sector is flashing a warning signal.
But despite Leamer’s research, it’s still prudent to think of housing as one of several factors that, in the aggregate, determine the path of economic activity. As I discuss in my book, Nowcasting The Business Cycle, history tells us that there’s usually some corner of the economy that’s stumbling at any given point in time, even when the broad trend is positive. As a general rule in the search for reliable warnings signs of the recession risk it’s essential to look at a broad, diversified set of indicators as a defense against false signals. Just as you shouldn’t look to energy or technology stocks alone for drawing conclusions about the US stock market, it’s short-sighted to use the housing market for judging business cycle risk.
Don’t misunderstand: a weak housing market could, in theory, be an early warning signal of trouble for the broader economy. But the risk looks minimal when so many other macro measures are issuing bullish signals as of the November economic profile.
The question is whether the wobbly signal for housing, at this point in time, tells us all that we need to know about the near-term outlook for the economy? Perhaps, but no one really knows which factors will, or won’t, play a pivotal role in creating conditions that lead to a new recession. What we do know is that each recession is different, the result of a varying set of triggers.
Will housing be a precipitating factor in the next recession? Maybe, but maybe not. At the moment, the broad trend isn’t about to slide off the cyclical cliff. But this rosy overview isn’t written in stone. Monitoring the incoming data is essential. Meantime, it’s best to refrain from letting one or two indicators dominate our evaluation of business cycle risk.
It’s possible that housing could drag down the rest of the economy, although the current set of numbers strong reject the possibility that such a dark scenario is fate. But let’s not become complacent just yet. Looking for clues that support an alternative outlook will animate the macro agenda on the other side of the New Year’s festivities.
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