Some people think housing is a driver of economic growth. But that doesn’t make sense to us.
Sure, a robust housing market creates a lot of jobs from construction all the way back through the supply chain.
But housing itself is a by-product of prosperity, not a creator of it. After all, who buys a house first … and then gets a job? It’s the other way around.
So we think housing is not a leading indicator, but a trailing indicator.
With that said, in addition to reflecting economic prosperity, housing definitely plays a role in driving economic activity. But not in the way most people think.
So let’s take a look …
Economic activity isn’t about asset values. It’s about velocity … transactions … how fast money is flowing through society. That’s why they call it currency.
But it isn’t really money that’s flowing. It’s credit. It’s a subtle, but important difference because you can’t create money from nothing. Only credit.
If you’re not familiar with the VERY important difference between money and credit, you should strongly consider investing in the Future of Money and Wealth video series …
… because G. Edward Griffin (author of The Creature from Jekyll Island) does an amazing job of explaining it all in an easy to understand way.
The fundamental principle to understand is that a loan is an asset to a bank.
When a bank makes a loan, they effectively create “money” from nothing by issuing credit.
Obviously, the biggest loans in most people’s lives are mortgages on houses. So that means banks are creating LOTS of “money” by extending credit.
Meanwhile, governments issue bonds, which are simply humungous, glorified IOUs … like a mortgage. Except the collateral isn’t a house … it’s the citizens’ earnings.
And when the mother of all banks, the Federal Reserve, buys government bonds, they are effectively creating “money” by issuing credit.
Now when all this “money” gets into the financial system it pushes asset prices up. But not evenly. And no one know for sure where it will all end up.
If lots of the new “money” goes into bonds, bond prices go UP and interest rates go DOWN. There was a LOT of that going on over the last decade.
Similarly, if it goes into stocks, then stock prices go up. There was a lot of that over the last decade also.
One big driver of rising stock prices has been corporations pigging out on cheap debt and then using the proceeds to buy back their own stock.
But remember, this isn’t economic activity … it’s just inflation of asset prices. So it’s a mistake to think a rising stock prices means a booming economy.
In fact, “stagflation” occurs when prices go up, but economic activity is slow.
And just last week, former Fed chair Alan Greenspan said he sees stagflation coming to an economy near you.
At the same time, fellow former chair Janet Yellen is warning of excessive corporate debt. We were just talking about that in our last commentary.
Funny. Neither Greenspan or Yellen has said anything about the Fed going insolvent. Pay no attention to that man behind the curtain.
Meanwhile, Fannie Mae’s economics team recently announced their prediction of slowing economic activity in 2019.
And just so you don’t think they’re merely jumping on the bandwagon, Fannie Mae Chief Economist Doug Duncan predicted this in his Future of Money and Wealth presentation on our last Investor Summit at Sea™.
All this to say, there are some notable experts saying the economy could be in for some headwinds in 2019.
So back to housing and its role in goosing economic activity …
Anyone paying attention knows housing prices have bounced back nicely from their 2008 debacle.
And almost everyone who bought early in this last run-up has built up gobs of equity. Good job.
Unsurprisingly, consumer confidence, cash-out refinances, and consumer spending all surged in 2018 … as households became equity rich … and then tapped that equity to SPEND.
In other words, credit flowed through housing to consumer spending which drove a lot of economic activity.
So it’s not housing construction that’s a leading indicator … it’s rising prices and equity.
But as housing price appreciation slows … it’s no surprise consumer confidence is dipping too.
Remember, consumers are usually the last ones to realize what’s coming.
So again, it’s the flow of credit into home prices and equity … and then the flow of credit through home equity to consumers … and then from consumers into the economy … that be a leading indicator of what’s coming down the line.
There’s one more nuance to consider …
As we’ve been pointing out for the last few months, there are LOTS of reasons to think more money is heading into real estate.
A combination of the best tax breaks, Opportunity Zones, and nervous stock investors fleeing Wall Street in record numbers to seek a safer haven in housing … all could have real estate setting up for a nice run.
But be cautious.
Because if Alan Greenspan is right about stagflation … rising prices without rising real wages and economic activity …
… then real estate PRICES could rise from big money seeking safety … while the rents you use to control the property could be under pressure.
Consider RentCafe’s recent year end report, which found the most popular things renters searched for in 2018 were “cheap” and “studio.”
So as we’ve been suggesting for quite some time …
… it’s probably safer to focus on affordable markets and product types… using long-term fixed financing … and focusing on solid cash-flows to position your portfolio to ride out a slow-down.
We’re not saying there will be slow down. But others are.
And it’s better to be prepared and not have a slow-down, than to have a slow-down and not be prepared.
And remember … asset prices and economic activity are NOT one and the same.
Until next time … good investing!
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