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02 17 2017 | by Victor Xing | Economics

Looming risks through the prism of bifurcated housing market

Abstract

The U.S. housing market faces a negative demand shock in the form of diminishing foreign investment:

  • Buoyant luxury house prices are vulnerable to easing demand from overseas buyers
  • Price levels of current high-end housing are beyond reach of organic domestic demand

Bifurcated housing market is a microcosm of broader U.S. economy conditions following years of uneven growth:

  • Tighter global monetary policies would have outsized impacts on U.S. asset markets and threaten unsustainable market practices (debt-funded stock buybacks), for the post-crisis recovery was led by beneficiaries of low-cost funding
  • Participants of the “old economy” left behind by the recovery have little excess capacity to buttress a retreat in risk sentiment

A bifurcated economy led by credit-sensitive industries is one with less resilience to negative economic shock.

Bifurcated housing market

Divergence between low and high-end housing markets in the U.S. became more pronounced by the end of last year despite signs of stabilization in the luxury sector.

Housing market

On one end of the spectrum, high-end properties’ on-going struggle with supply glut was not an isolated event as luxury homes in New York, Boston, Houston, Aspen, and parts of California came under pressure, and a few common catalysts were noted by sector participants:

At the same time, buyers in the ultra-competitive low-end market are facing persistent supply shortages. This too, is an on-going trend: a March 2016 Trulia blog post highlighted three reasons behind low starter and trade-up home supply, and they remain valid nearly a year later:

  • Institutional investors and affluent buyers (buy-to-let) armed with cheap credit bought many foreclosed homes during the recession and turn them into rentals
  • Large share of lower-end homes are still underwater with reluctant sellers
  • Potential premium-sector buyers returned to the mid-range sector after being priced out by rising valuation

Risk catalysts from abroad

The U.S. housing market is vulnerable to an acute negative demand shock.  In the years preceding 2017, capital inflows from China acted as a steady tailwind to the high-end and mid-range housing markets.  The December 2016 decision by the PBOC to restrict investment-related FX purchases, however, changed the funding equilibrium (this took effect following the most recent Redfin report, thus not yet visible in most economic data releases as of Feb 17).  With high-end housing sectors already experiencing supply glut, a demand shock couldn’t have come at a worse time.

Divergence within the housing market mirrors the uneven post-crisis recovery, and it offers a glimpse into risk factors looming within the U.S. asset market and the broader economy.

Two-speed economic recovery

In essence, the bifurcated U.S. housing market signaled that the economic engine has not been firing on all cylinders; to make matters worse – some segments of the economy are overheating from excess stimulus, while others are sputtering along:

This bifurcated scenario is sustainable during expansionary phase of the credit cycle, as economic participants in growth sectors (tech-sector being the present day example) enjoy higher wages, and business expansion can be funded at low costs.

However, a credit tightening scenario can easily disrupt the current growth model and buoyant asset prices (wider credit spreads would make debt-funded stock buybacks uneconomic).  At the same time, other segments of the economy would remain ill-prepared to buttress the negative demand shock. Without policy accommodation (and the Federal Reserve, People’s Bank of China, the European Central Bank are steadily tightening policy), a bifurcated economy has a fraction of “old normal” risk tolerance and asset price resiliency.

Next article01 11 2017 | by Victor Xing | Economics

Financial risk contagion: China’s capital outflow