Will a Recession Cause a Housing Crash in 2022?


Will a Recession Cause a Housing Crash in 2022?

Source: 2jenn / Shutterstock

This article is excerpted from Tom Yeung’s Profit & Protection newsletter dated July 26, 2022. To make sure you don’t miss any of Tom’s picks, subscribe to his mailing list here.

Depiction of the housing market on a blue graph
Source: 2jenn / Shutterstock

Two weeks ago, I warned investors about stresses in the housing market: “Since 1890, changes in the interest rate have explained nearly a quarter of home price moves over a decade… Investors should brace themselves for decelerating prices.”

Right on cue, America’s largest homebuilder, DR Horton (DHI) announced another set of guidance cuts. It now plans to sell just 83,000 to 85,000 homes this year, 9,000 fewer than originally expected. 

It was an obvious call. Rising mortgage rates mean that monthly payments for new homes are 50% more than they would have been six months ago; DR Horton’s deal cancellation rate sits at 24%, compared to 17% a year earlier.

And investors should be worried about homebuilders. Over three-quarters of U.S houses begin construction without a sale contract, according to the Census Bureau. If home prices fall between construction and completion, homebuilders are on the hook for the loss. That’s particularly true for firms like DR Horton, which almost exclusively build “spec” houses — where construction starts without a sale contract in hand.

iBuyer stocks like OpenDoor Technologies (OPEN) are also playing with fire. Like bank prop traders or bitcoin mining firms, iBuyers magnify their potential returns by speculating on inventory prices. When prices go down or stagnate, these companies are the ones holding the hot potato.

Slowing Down, But Not Stopping

The data, however, still points to a slowdown rather than an all-out crash. Last week, mortgage rates settled at 5.5%, a slight reprieve from a month earlier…

… and major relief for homeowners nationwide.

Demand for other rate-sensitive goods is also becoming less volatile. Last week, the Manheim Market Report found that used car prices saw higher-than-normal but decelerating declines. The cost of SUVs inched up 0.2% despite record gas prices.

That’s because the average American still isn’t financially stretched, though it may seem that way. According to data from the St. Louis Federal Reserve, mortgage debt service payments as a percent of disposable income remain at 3.9%, lower than the 4.1% rate immediately before the 2020 pandemic and barely half the rate found leading up to the 2008 financial crisis. Americans are more indebted than several months ago, but it comes on the heels of years of deleveraging.

<em>A decade of mortgage deleveraging.</em>

Researchers at The Economist now estimate that “households across the rich world probably still have some $3trn or so in ‘excess’ savings accumulated during the pandemic.” Much of that cash is finding its way into travel, big-ticket purchases and other luxuries seen most recently on your Instagram feed.

Thursday’s initial GDP results will unlikely change that fact. One-off circumstances caused America’s negative Q1 GDP reading. And a technical recession caused by a negative Q2 reading would “not pass the smell test,” according to the same writers (generally, a recession is defined as two consecutive quarters of negative growth).

The slowdown from Fed tightening hasn’t yet filtered through to the economic data.

The Housing Stocks That Benefit in a Slowdown

Still, it’s too early to jump into the most speculative stocks. Today’s markets look much like 2015 to 2016, a period where a commodity crash depressed demand for the riskiest of assets. Gold and Bitcoin (BTC) prices would trade sideways for much of the two years, while cyclical firms like Eagle Bulk Shipping (EGLE) to coal miner Peabody Energy (BTU) would lose virtually their entire market capitalization.

Fast forward to the present day and market stresses are again driving the price of high-beta stocks into the ground. Since January, shares of high-risk moonshots like Fubotv (FUBO) and Hydrofarm Holdings (HYFM) have turned into rounding-error shells of their former selves. Even mega-cap tech firms such as Apple (AAPL) and Amazon (AMZN) are tapping on the brakes; a report from the Financial Times found that the most prominent tech firms are all rethinking their hiring strategies.

Blindly investing in tech stocks is no longer a recipe for success.

The pain however, has spared many promising tech firms

This month, Profit & Protection favorite Beam Therapeutics (BEAM) has risen 50% on increasing optimism over its base editing technology — an alternative to the less accurate CRISPR-Cas9 gene editing tool. And top pick Etsy (ETSY) similarly missed the memo about the ecommerce slowdown; the handmade goods store has seen shares rise 25% since its recommendation.

For stock investors looking for real estate exposure, the market dislocation also provides many once-a-decade deals. Appfolio’s (APPF) strength in touchless building management has thrown the firm’s growth into hyperdrive; the company is a takeover target for the likes of private equity firm Thoma Bravo or Salesforce (CRM). And Redfin (RDFN) is added to the Profit & Protection tactical trade list for its extraordinarily low share price relative to growth. These are the kind of firms that stand to benefit even as markets stagnate for the next several months.

A Recession in Slow Motion

In 2020, the Covid-19 pandemic had me scrambling to readjust my stock positions. News of the virus’ infectiousness, mortality rates and spread came so quickly that projections made in the morning were outdated by lunchtime.

Meanwhile, the 2022 recession (if one happens) has become so widely expected that markets meet each new data point with a figurative yawn. The Dow Jones Industrial Average fell just 238 points the day the Bureau of Labor Statistics revealed June’s record 9.1% inflation.

That means investors have time to make important decisions. Top Profit & Protection picks like Crispr Therapeutics (CRSP), Desktop Metal (DM) and ZScaler (ZS) have traded sideways for a month, giving foot-dragging investors time to jump in.

But a slow-moving market also creates the temptation to jump in too early on turnarounds. Companies like Robinhood (HOOD) and Coinbase (COIN) will continue to frustrate investors with their lack of price action. For those looking to “buy the dip,” this week’s economic news will likely give more reason to wait.

Article printed from InvestorPlace Media, https://investorplace.com/2022/07/will-a-recession-cause-a-housing-crash-in-2022/.

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