The National Association Of Homebuilders sentiment index fell to 15 in March from 17 in February. While the index is well off its record low of 8 set back in January 2009, it remains very depressed. The index is set up so any reading below 50 indicates contraction, and the current rate is well below anything seen prior to the Great Recession (although the history only goes back to 1983).
The builders index is a pretty good leading indicator of housing starts. The graph below (from http://www.calculatedriskblog.com/) shows the history of the index plotted against single family home starts. Historically residential investment, with new home construction being the largest part of that, has been the principal locomotive that pulls the economy out of recessions.
The dip in the home building index suggests that when the new housing starts and permits data are released tomorrow morning, it is likely to be disappointing, or at least lower than expected. There is a good argument to be made that with the huge overhang of housing on the market, particularly if one factors in the shadow inventory of mortgages that are deeply delinquent or in the foreclosure process, that building more new homes is not really what the economy needs right now. Until household formation picks up, building more of what we already have too much of is not a wise use of resources.
In the long term that is certainly true, but for the recovery, a weak pace of housing construction means that the economic recovery will be extremely sub-par.
The Fate of Construction Jobs
Construction workers have been a big swing factor in total jobs in this economy, particularly for those without college educations. After the 2001 recession, overall job creation did not start until August of 2003. Over the next three years, the economy added a total of 6.430 million jobs, of which 965,000, or 15.0%, were in construction.
In the process, construction workers as a percentage of total workers rose from 5.2% to 5.7%. While the bulk of total jobs gains were finished by that point, the overall economy did continue to add overall jobs, eventually hitting 137.881 million in November 2007, up from 136.352 million in August 2006.
Construction jobs started to fall in August 2006, and have since declined by 2.170 million, and have accounted for an astounding 31.8% of all jobs lost since August 2006 or 5.5x there total percentage of jobs then. It is likely that the skills needed for construction jobs are not that readily transferable to other jobs.
Job availability is one of the key factors in housing formation. If a young person does not have a job, he will keep on living with mom or dad, not go out to get a place of his own. If someone has been foreclosed upon and she does not have a job, she will move back in with parents or other relatives.
This sets up a huge chicken and the egg problem. Without construction jobs, it will be very hard to create a lot of jobs overall in the economy. If the number of jobs in the economy is low, so will be the rate of household formation. If the rate of household formation is low, so will be the demand for new houses, and with it construction jobs.
The Role of Non-Residential Construction
Non-residential construction is not likely to pick up the slack, since not only does the country have too many houses relative to demand, but judging by the vacancy rates, we also have far too many strip malls, hotels and office towers. A “Cash for Caulkers” program is a good idea since it would allow these people to use their current skill sets without adding to the inventory overhang. It would also increase the country’s overall energy efficiency, thus helping on the trade deficit front, as well as reducing carbon emissions.
It would sure beat just paying construction workers unemployment benefits, and it would not push people into destitution the way that cutting off unemployment benefits would (especially when there are not a lot of jobs available that would make use of those skills). However, even a major problem would only put a dent in the problem.
The firms that are most immediately affected are of course the big homebuilders like D.R. Horton (DHI). However, the effects filter much further through the economy since it takes a lot of economic activity to build a home.
Fewer new homes being built also means less demand from cabinets and faucets from Masco (MAS) and Fortune Brands (FO). It means less demand for wood from Weyerhaeuser (WY). It means lower tool sales for Black & Decker (BDK). Lower employment means lower economic activity across the board for retailers and for the makers of everything the retailers sell.
Housing is in a sense the ultimate durable good. Demand for durable goods can be pulled forward or pushed back depending on the overall economy. During the early years of this decade, we pulled forward an enormous amount of demand for housing. Just look at how far above previous levels housing starts rose during the last expansion.
Prior to 2000, single family starts had never exceeded 1.4 million. From mid-2002 through mid-2006, we never fell below that level, and actually exceeded 1.8 million for a while. Well, payback is a … let’s put it this way: it is going to be “dogging” the recovery for a long time to come.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.
