Update No. 69 – 22/07/12

Regular readers will know I make a habit of following the US Housing Starts as an important global economic indicator, for despite the rise of China, it is still the case that when the US hums, the globe will be in generally good economic shape (provided Europe doesn’t choke it…).

The key reason for my interest is that the current slump the US economy finds itself in is primarily driven by the housing oversupply generated through the housing bubble, which ‘began’ to end in 2005 or 2006, and really blew up alongside the GFC, when the value of US housing fell by about 1/3 (the falls were over 50% in places) from mid-2006.

The reason for the scale of these falls were the usual ‘bubble’ behaviour of over-exuberance, driving prices beyond the levels economic growth was capable of supporting, with an accompanying over-building as participants tried to ‘cash-in’.  The whole thing eventually succumbed to ‘Herbert Steins Law’ – "If something cannot go on forever, it will stop,”

Now in order to understand why I believe the US housing starts to be so important, we need to understand the factors current and historic.  Currently, the new housing creations, including demolished existing houses are thought to be in the area of 1.2m to 1.5m per annum. This number is slightly below the historic average (despite increasing population growth), because the durability of homes is increasing and there has been a recent upward trend in people per house (through offspring living at home longer etc).

Historically, in the roughly 700 months between 1950 and 2008, the average level of construction was 1.54m housing units per annum, measured monthly.  Over this 700 month stretch, a total of 22 months registered less than 1 million housing starts.

More recently, in May 2008, the US Housing Starts figure dipped below 1 million and has remained below 1m ever since.  The annualised monthly figure bottomed at 490,000 in January 2010 and has generally slowly grown ever since. The average monthly figure since May 2008 has been 639,500.  This basically means over the last 4 years, there have been about 2.85m fewer homes built than natural growth requires.  There was absolutely an oversupply, but by any measure, substantially all of that oversupply must have been absorbed by now.

The June figure, released Wednesday this week showed 760,000 starts in June 2012, the highest number since October 2008, up 6.9% month on month, up 23.6% year on year, and in my view, the most vigorous sign of recovery we’ve seen in the US economy for some time. Given that ‘permits issued’ were down and ‘authorised not started’ figures were flat, July will unlikely see the same growth.  However, as I suggested here in February, if US Housing Starts are at 800k by December (and I am much more confident of that now than I was then), a sustained recovery in the US will be underway.  Once the monthly figure breaks back above 1 million (perhaps by this time next year), it would be hard to imagine unemployment remaining above 7% for very long. I was actually surprised the US market didn’t take this news more positively; I thought the ¾% stock market rise that accompanied the news was a relatively muted response to a pretty positive piece of economic news, but there was accompanying negative retail data in fairness.

I am generally very positive about the medium term prospects for Australian stocks on the back of my ‘more positive than most’ view of the global condition.  There is much concern about the apparent slowing of growth in China, but remember Japan STOPPED growing (basically) in 1990 and remained our biggest trading partner for nearly 20 years.  Australia has not experienced a recession since 1991, and despite the Carbon Tax & Mining Tax commencing in July, I can’t imagine a recession is very likely.  We need to remember we are still basically a commodity currency and if substantial falls in commodity prices occur, they will almost certainly be accompanied by significant AU$ depreciation, significantly dulling the effect on our economy.

We finally managed to deploy some of our fresh capital this week and although I had to pay a little more for some of the stocks than I’d been trying to, I believe we will do very, very well out of these buys in the long run, the start of financial 2013 has been very kind to us, we are up over 6% and nearly 4% ahead of the market.  Long may it continue I’m sure you are all thinking! – Tony Hansen 22/07/12.

*Unaudited figure to be confirmed externally

EGP Fund No. 1 Pty Ltd. Up by 6.21%, leading the benchmark by 3.64% since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 9.39%, leading the benchmark by 17.54% all-time (April 1^st 2011).