U.S. Housing Market with a Closer Look at Dallas: After 6 years of steady improvement for home builder optimism, we are finally starting to see some significant pull back from 2017 highs. This data is supported by declines in profitability for home builders due to higher costs and declines in prospective buyer traffic. As a result, housing starts and building permits have seen a dip as well. On the buyer side, as interest rates continue to rise, houses will become less affordable, thus allowing less buyers to even participate in the market. We are already seeing these effects in real and expected home sale data and surveys. Part of our analysis of the US home market will include a close look at the Dallas, Texas market which fared well in the last downturn, but was featured in a recent WSJ article that called it a “canary in the mine shaft.”
Our Takeaways: The housing component of the US economy is an important one, not only because it is a sixth of the overall economy, but also because of the many interdependent relationships between business activity, real asset prices, interest rates, consumer strength and credit markets. At a high level, much of the trends mentioned above are not that surprising at this point in the cycle. Builders are less optimistic about future prospects because input costs have been getting more expensive (a trend that is likely to continue especially if trade issues between China and the US continue unresolved) and buyers are weak to the home product on the market right now since builders have focused on higher end new builds and wages have remained flat. However, these points alone are not cause for ringing alarm bells just yet. Production and sales numbers have pulled back from late 2017/early 2018 highs, but are still coming in in-line with estimates which indicates this pull back is not entirely unexpected. Furthermore, inventory levels are below previous years going back to 2012 at this time of year with the exception of 2017. It appears that low inventories from last year which culminated in the price crescendo this year coupled with slowing production this year has kept a good market balance between supply and demand. So with normal pricing dynamics appearing to occur, why are alarm bells going off in the Dallas market? To start, recent data from the Dallas FED is showing real, meaningful slowdown in business (particularly manufacturing) activity for that reporting area. The current financial news theory is this is related to the precipitous decline in oil prices this year. There are good reasons both for and against why this theory could be correct, but for our question on the housing market the only thing that is important is that there is in fact a slowing in business activity for the area. During the last housing crisis, the market in Dallas fared very well. While prices in other markets were down 30%, or more, Dallas only saw a modest 10% pullback. So, when things turned around in this cycle and the business economy in Dallas started booming, home builders took advantage pushing median home prices to 50% above their 2007 peak. This worked well for several years, but now buyers are clearly straining against affordability with home sales dropping 3.6% year over year in October and home price appreciation only growing at half the rate it was a year ago. While the initial conditions and some of the aspects of what has happened during this current upcycle are similar to what is happening in other hot housing markets such as Seattle and San Francisco, a key difference is how much equity buyers in Dallas are bringing to the table compared to other markets. According to data from Black Knight Inc., on average, Dallas households finance 83% of their purchases compared to only 79% and 74% for Seattle and San Francisco respectively. This points to the possibility that prices have been more dramatically increased due to access to credit and/or the proportion of buyers left in the market who have sufficient means and credibility to afford financing is arriving at a low point. All in all, it appears that at least for the moment there are some factors that are specific to the Dallas market that are causing the recent declines, so the idea that it could possibly be some kind of canary in a coal mine seems a little premature at the present time.
Orange Juice Prices Getting Squeezed: Two interesting things have been happening recently in the world of orange juice. First, the commodity price (the price paid by manufacturers, not the price we see as consumers) has been falling dramatically since August of this year going from spot prices of 170 to below 135. Second, and this has been coming as a surprise to some consumers who may have not already noticed, the sizes of orange juice carafes sold in stores is shrinking. Standard 59-ounce sizes dropped to 52-ounces seemingly overnight for all of the large juice manufactures like Tropicana and Minute Maid. Headlines are claiming it is due to a citrus shortage, retailers are saying it is in response to changing consumer behavior, and industry representatives are disputing claims that consumers have changed their preferences.
Our Takeaways: This story is an interesting example of supply and demand fundamentals playing out in the commodity market. The citrus industry is nice because of the relative simplicity of the market dynamics involved - the process from growing to consumption is a pretty straightforward one. To add some brief context to our analysis, the industry has faced challenges from both declining consumer consumption and disease that has run rampant through Florida orange groves both killing trees and making the surviving ones less productive. Going back to the analysis, let’s start on the consumer (consumption) side of the equation. Data indicates that something is happening to make consumers drink less orange juice with total gallons consumed falling about 50% since 2001. While some of this decline is explained by higher prices and lower output, it is estimated that about 37% of the this approximately 50% decline is not due to one of those factors. This is where changes in consumer preferences really become apparent. The working theory on these changes is that consumers are more conscious about sugar intake in their diets and that they are eating breakfast less frequently often opting for quicker bar or shake options if they do decide to eat. On its own, these factors on the consumer side would suggest a long term price decrease for the commodity, but in fact, since 2000, prices on the whole have been increasing with a huge increase between 2000 and 2008. To understand this further, let’s turn to the producer side of the equation. The disease affecting many of the orange groves in Florida have been a tremendous headwind in recent decades. This affects both sides of the profitability formula for producers by lower their productivity while also increasing their costs. Combined, these forces serve as a negative factor for production. This is supported by production data since output has fallen by about half looking at the time period from 2000 to 2017. All things being equal, with supply decreasing we should see prices increasing. This is exactly what we have seen, right up until 2007/2008 when the long term price trend broke in the other direction. So if headwinds against producers are still persisting, then why did the price trend start to decline around 2008 and besides some seasonal jumps due to hurricanes continue to the present? The answer ultimately lies in the relative strength of the factors affecting supply and demand. While the upward pressure from constrained supply pushed prices higher in the early 2000s, the rate of consumption has decreased exponentially in recent years. We expect this decreased consumption to be persistent, so the citrus industry as a whole appears to be headed for even more difficult times.
Black Friday 2018: A (Mostly) Online Story: Headlines touted this recent shopping phenomenon as giving retailers a much needed boost and as a strong start to the holiday season. However, a few things stood out as being different compared to years past. Media attention focused less on long lines at stores, or fights breaking out over TV bargains, but instead on the record dollars companies pulled in from online sales. Mobile sales also featured prominently in the headlines since both mobile and online broke records of $2 billion and $6.22 billion respectively on Black Friday.
Our Takeaways: While it was clear that online, particularly mobile, sales were the big story from this Thanksgiving shopping season, the real thing we are trying to answer every year with holiday sales figures is how strong is the US consumer this year? While higher YoY online sales are great (if not expected given general consumer trends) it is necessary to look at the bigger picture to get a thorough understanding how how shoppers are spending. A look under the hood reveals that the Thanksgiving shopping weekend may not have been as strong as headlines lead on. Total shoppers in store and online took a dip from going from 174 million in 2017 to 165 million this year. Even more telling, average dollars spent fell about $20 going from $335 to $313. This works out to an over $6.5 billion drop in total dollars spent for the weekend. From these numbers we can see that the decline in in store traffic is not being made up or in some other way being captured in online sales. There have been some comments from those in the retail industry who we would assume have come to the same conclusion we have to the effect that lower/slower sales are to be expected because consumer has been shifting towards a longer spending season, or that this year is different because we have an extra week between Thanksgiving and Christmas than is typical. While these may present valid explanations for the data, we would caution against such blind optimism in the face of such negative data. However, the holiday shopping season is still upon us, so we will maintain a close watch on this litmus test of consumer strength.