Is Winter Coming Early?

For months, the warning signs have been clear. The typical spring surge along the Front Range never materialized, and buyers haven't re-entered the market despite a modest dip in rates. Whether it's fear of higher homeownership costs, concerns about the upcoming election cycle, or depleted savings, something is shifting in the housing market. This market lethargy has been overshadowed by an unstoppable stock market, but such a disparity can't last forever. Corporate earnings hinge on consumer spending, and if the rising cost of living has exhausted American consumers' savings, we could be facing a period of slower growth and subdued gains across multiple asset classes for the foreseeable future.

The Skim:

1. Divergences Never Last Long

2. Demand — Unch’d

3. Supply — Building

Divergences Never Last Long

Here’s a question for you: which is the bigger number: the total value of all homes in the United States or the total market capitalization of the S&P 500? If you guessed the housing market, you’re right. According to Redfin and CoreLogic, the total value of all homes in the U.S. is approximately $47 trillion, while the market cap of the S&P as of the end of June 2024 was $45.8 trillion. This stat is crucial because the size of these asset classes means they often move in similar directions, linked by the “wealth effect” when economic shifts occur.

For working and middle-class Americans, around 50% of their net worth is tied up in their primary residence, while stocks make up only 10% of their portfolios. Thus, when the housing market appreciates, homeowners see a significant increase in their net worth. This increased net worth can be leveraged through cash-out refinances, HELOCs, and second mortgages, boosting stock market growth. Americans typically spend their excess cash, so increased home equity often translates into more revenue for major companies. Higher revenues lead to higher earnings and, consequently, higher stock prices — a phenomenon known as the “wealth effect.”

Conversely, the wealth effect works in reverse, as dramatically demonstrated during the Great Financial Crisis of 2007-2009. Excessive debt worsened the correction, starting when the wealth effect reversed. Falling home prices led to foreclosures, further declines in home prices, and losses of home equity. This crash caused many Americans to lose a large portion of their net worth, severely impacting corporate earnings. The Federal Reserve's policy of quantitative easing aimed to reverse this by lowering long-term interest rates, encouraging investment in real assets (like homes), and restoring home equity for those who could endure the downturn.

Significant divergences between the housing and equity markets warrant close scrutiny. Here’s a chart of the S&P 500, which has been rising steadily since October 2023.

In contrast, here’s a chart of XHB, an ETF tracking national homebuilders, which peaked in March 2024 and, aside from a brief rally on July 11th due to lower-than-expected inflation data, has been declining.

Homebuilders face challenges as homes linger on the market longer and construction costs remain high, squeezing their margins. The recent rally due to lower inflation data suggests that mortgage rates might fall, but this could be misleading. Lower inflation currently results from reduced consumer spending, indicating that consumers may still struggle to afford new homes at the previous pace. Moreover, slower home price increases mean that protecting margins through financing incentives will be tougher for homebuilders.

While 10-year interest rates dipped slightly on inflation news, the decline wasn't enough to justify a 6% rally in homebuilders, indicating the move was likely a short cover rather than a fundamental change in the sector. Consequently, we anticipate a sluggish housing market, potentially affecting the broader economy if housing inventory continues to accumulate.

Demand — Unch’d

Supply — Building

Let’s check in on our trusty table summarizing the Denver metro housing market within a 10-mile radius of downtown Denver:

The Denver metro area housing market is showing signs of significant change after months of gradual shifts. In June 2024, the number of homes put under contract was lower than in June 2023, continuing a trend of declining contracts year-over-year for 11 of the past 12 months. Over the last three years, we’ve seen decreasing contracts for 26 out of 27 months, driven by higher interest rates and home prices. On the sales side, there was a larger-than-expected drop in closings, with monthly sold units lower than the previous year for 31 out of the last 36 months, indicating fewer buyers can afford current mortgage rates and prices, leading to increasing supply.

Although there wasn’t a significant year-over-year change in new units hitting the market in June, active supply dropped slightly on a relative basis. However, the overall trend of increasing supply continues, particularly after a drop in sold units last month. The typical "spring pop" did not materialize this year, leading to a steady build-up of supply over the last eleven months. Days on Market (DOM) is rising, with single-family homes staying on the market two days longer and attached homes ten days longer than last year. Buyers are becoming more strategic, taking their time, and negotiating for better terms.

This slowdown signals that the "froth" is out of the Denver metro market, and prices are adjusting accordingly. If you’re looking to sell, now is the time to act before the market potentially slows further. For buyers, this is an excellent opportunity to leverage increased negotiating power as the market continues to cool. Reach out to us now to get pre-qualified and ready to secure a fantastic deal when the time is right.