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Oliver's Insights Oliver's Insights

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					  Shane Oliver, Head of Investment Strategy
  & Chief Economist


  The US housing sector
  turning 1 or 2
  Headingthe corner                                                                                                       EDITION 9 – 16 MARCH 2012




  Oliver’s                                                                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
  Insights                                                                and advances in fracking technology (by which shale kilometres
                                                                          below the surface is fractured using explosives, allowing oil to be
                                                                          released and flow to the surface) and oil prices around US$100
 Key points                                                               per barrel are making it economic for these reserves to be tapped.
 >   Bulletsit’s too early to call the end of the secular bear
     While                                                                Some even see the US becoming self sufficient in oil again in the
                                                                          decades ahead.
     market in US shares, there are some signs of light in the US
     economy, notably in manufacturing, energy production and             US housing bottoming
     housing.
                                                                          A collapse in the US housing sector was at the core of the sub-
 >   In particular, after triggering the global financial crisis, the      prime mortgage crisis in the US which subsequently morphed
     US housing slump appears to be over and a recovery in                into the global financial crisis. US house prices and housing
     prospect.                                                            construction surged into the middle of the last decade as lax
                                                                          lending standards underpinned a huge surge in home ownership.
 >   This will help prolong the current US economic recovery,
                                                                          Boom turned to bust, starting around 2006 as housing supply
     boost household wealth and over time and add to global               started to surge and it became harder for sub-prime borrowers
     commodity demand.                                                    to refinance 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
Introduction                                                              has seen the volume of private residential investment collapse
Starting with the bursting of the technology bubble in 2000,              by about 60% from its peak in the mid 1990s, resulting in a huge
the fortunes of the US economy have waned. Since then, the                drag on US gross domestic product (GDP) growth.
US has seen two recessions with the last being the worst since
the 1930s, a rising trend in unemployment, the bursting of a              Why the worst is likely over for US housing
corporate debt bubble with the tech wreck and the bursting of a           There are good reasons to believe that the US housing market is
housing debt bubble with the sub-prime mortgage crisis. So it’s           bottoming and starting to recover.
little wonder the US share market has been spinning its wheels            The first thing to note is that most US housing indicators have
in a secular bear market. Some commentators even talk of a                stabilised. Home sales have been bouncing along a bottom since
permanent decline for the US.                                             2009. Housing starts and permits to build new houses have been
The high level of US public debt, ongoing private sector deleveraging,    bottoming since late 2009. Furthermore, the National Association
less business friendly policies, demographic trends and the absence       of Home Builder’s conditions index has now broken out on the
of extreme share market undervaluation suggest the secular bear           upside, pointing to a rise in starts ahead.
market in US shares may not be over yet. That said, it would be
                                                                          Home builders conditions point to stronger housing starts
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           2500
                                                                                                                                          US Housing
                                                                                                                                                              80
                                                                                                                                                              70
importantly, there are some signs of light at the end of the tunnel for   2000                                                            Starts, '000
                                                                                                                                          (LHS)               60
the US in manufacturing, oil production and housing. This note takes      1500                                                                                50
a look at these sectors, focusing on the latter as housing was the                                                                                            40
                                                                          1000                                                                                30
original driver of the global financial crisis.
                                                                                                                                                              20
                                                                           500                    National Assoc of Home Builders'
US manufacturing renaissance                                                                      conditions index (RHS)                                      10
                                                                              0                                                                               0
Recently there have been numerous examples of companies                           86   88   90   92   94   96   98   00   02    04   06     08   10      12
setting up manufacturing plants or expanding production in                Source: Bloomberg, AMP Capital
the US over locations in Canada, Mexico, Japan or the emerging            Second, the number of vacant homes is now starting to fall
world. These include Maserati, Toyota, Honda, Nissan, Kia, Intel,         sharply. Over time the equilibrium number of vacant homes has
Whirlpool and Caterpillar. In fact for the first time in over 35           increased in line with the rising population. This is proxied by
years, annual growth in manufacturing employment is exceeding             the long-term trend line in the next chart. It can be seen that
employment growth elsewhere in the US economy. The key                    the gap between the actual number of vacant homes and its
drivers of America’s manufacturing renaissance are restrained             long-term trend is now closing rapidly. Related to this, household
unit labour costs in manufacturing (which have been unchanged             formation is likely to rise sharply. Since 2006 it has been running
for the past 30 years), rising wages in emerging countries, the           well below that implied by population growth and has collapsed
low US dollar (US$) after a decade long slump, and cheap energy           from a record 2 million to around 700,000 last year. This reflects
prices helped by surging natural gas supply. While it’s early days        tough economic conditions causing young people to stay at home
yet, America’s manufacturing renaissance has further to go.               with their parents for longer and is likely to rebound as economic
                                                                          conditions improve. If the number of vacant homes continues to
Surging oil production                                                    decline at the same rate as the last couple of years and household
US natural gas supply has been surging for years resulting in             formation picks up then the overhang of housing will likely be
low prices. More significantly, a few years ago US oil production          gone by year end.
The US inventory of vacant houses has almost fallen back                                                                   Similarly, house price to income and house price to rent ratios
to its long-term trend                                                                                                     have collapsed, pointing to good value in US housing.
12000                                                                                                                      US house prices back to fair value or cheap
                Thousands                                                    Total vacant
10000                                                                           houses                                      30
                                                                                                                                    % deviation from long-term average
                                                                                                                            25
 8000
                                                                                                                            20
 6000                                                                                                                       15                               US house price to
                                                                     Long-term trend                                        10                                   rent ratio
 4000                                                                                                                         5
 2000                                                                                                                         0
           65        70     75            80     85            90       95            00        05         10                -5                                               US house price to
                                                                                                                           -10                                                   income ratio
Source: US Census, AMP Capital                                                                                             -15
                                                                                                                                  1991         1995          1999             2003         2007           2011
Third, the stock of unsold new homes has largely vanished. It is
now at its lowest level since the 1950s. This seems more extreme                                                           Source: OECD, AMP Capital

when it is compared with the fact that the US population has                                                               The improvement in US house price valuation measures stands
more than doubled since then.                                                                                              in stark contrast to the still very overvalued Australian housing
                                                                                                                           market…but that’s a different story. Note both the US and
The stock of unsold single family homes for sale has almost                                                                Australian charts use OECD data for consistency.
vanished
  600
                                                                                                                           .... in stark contract to Australian housing which remains very
                Thousands
  550                                                                                                                      expensive
  500                                                                                                                        60
  450                                                                                                                        50      % deviation from long-term average
  400                                                                                                                        40
  350
                                                                                                                             30
  300                                                                                                                                                   Australian house
  250                                                                                                                        20                         price to rent ratio      Australian house price
  200                                                                                                                        10                                                      to income ratio
  150                                                                                                                         0
  100                                                                                                                       -10
           65        70         75        80         85         90          95         00            05         10          -20
Source: Bloomberg, AMP Capital                                                                                              -30
                                                                                                                                  1991          1995          1999            2003          2007           2011
Fourth, while the US mortgage foreclosure rate remains high,                                                               Source: OECD, AMP Capital
the delinquency rate is slowing as are the number of new
                                                                                                                           The bottom line is that the US housing market appears to have
foreclosures, pointing to a decline in foreclosures ahead.
                                                                                                                           bottomed with recovery in both activity and prices likely.
Falling mortgage delinquencies point to falling foreclosures
                                                                                                                           What a recovery in US housing would mean?
  11                                                                                                                 5
           %
  10                                                                                                                       A recovery in US housing has several implications.
                                                                                                                     4
   9                                                                                                                       >   First, by reversing a significant drag on the US economy
   8                                                   % Dwellings in                                                3
   7                                                  foreclosure (RHS)
                                                                                                                               it should help perpetuate economic recovery.
   6                                                                                                                 2
                                                                                                                           >   Second, this is likely to be reinforced by a boost to US
   5
   4
                                                                                                                     1         household wealth as house prices stabilise and recover.
                            Delinquency rate, % (LHS)
   3                                                                                                                 0     >   Third, residential construction is a key user of raw materials
        98      99    00    01       02    03   04        05    06      07       08        09   10        11
Source: Mortgage Bankers Assoc of America, AMP Capital
                                                                                                                               like copper, therefore a recovery in US housing construction
                                                                                                                               should boost global commodity demand.
Finally, housing affordability has reached a record level. While this has
not been acted upon given the excess supply of housing and tough                                                           Concluding comments
economic conditions, we are likely to see greater demand for houses
as the excess supply dwindles and economic conditions improve.                                                             While the secular bear market in US shares that began 12 years
                                                                                                                           ago may have further to go, there are a number of positives
US housing affordability is at record high                                                                                 suggesting there is light at the end of the tunnel. In particular
200                                                                                                                        the US housing sector appears to be bottoming.
180
                                                                                                                           Dr Shane Oliver
160
                                                                                                                           Head of Investment Strategy and Chief Economist
140
                                                                                                                           AMP Capital Investors
120
100
 80
 60
      70        73   76    79        82   85    88        91    94     97        00    03       06    09        12
Source: Bloomberg, AMP Capital




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