Schwab Guide To Economic Indicators: Housing Starts and Building Permits

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Schwab Guide to Economic Indicators: Housing Starts and Building Permits
by the Schwab Center for Financial Research
November 30, 2007

What is it?
It's a monthly report covering two widely-watched phases of the construction process of new, privately-owned residential structures. According to the U.S. Census Bureau, housing starts measure when "excavation begins for the footings or foundation," building permits are a total of the number of "housing units authorized" to be built.

What is its relative importance?
High. These forward-looking reports are considered a meaningful barometer of housing, which has a major impact on consumer spending. Good examples of this are represented by the purchase of appliances, building materials, furniture, other home furnishings and landscaping for these new homes. Consumer spending is also supported by the various ways home equity can be turned into buying power for whatever purchase they wish or consolidate debt using home equity loans, lines of credit or refinancing their existing mortgage(s). Equity is also turned into buying power when trading up for a bigger home, or trading down for a smaller home and utilizing the difference for other purchases or debt reduction. With consumer spending accounting for nearly two-thirds of all economic activity, this report is one of several key reports monitored by the Federal Reserve in setting monetary policy.

What impact does it have on the market?
The degree to which housing starts and building permits, along with revisions, meet expectations is typically one of the most influential aspects of the report.

When the two components move in opposite directions, building permits usually garner more of the market's attention because they are more forward-looking than housing starts.

If the trend in housing starts and building permits exceeds forecasts in a way that hints the economy is overheating, bond prices typically fall (yields rise) on the outlook for greater overall economic demand, potentially higher inflation and an increased chance that the Fed will hike interest rates. Stock prices may also fall.

Why?

A rise in bond yields can make bonds more attractive once the fall in bond prices settles down. Compared to where the weights of stocks and bonds were in your portfolio, the typical thing to do in response to this change in valuation would be to sell some stocks and put the proceeds into bonds. Even if corporate profit growth seems supported in this time of strong housing starts and building permits, the market will likely see it as being short lived given expectations for impending rate hikes and eventually slower economic growth.

Alternatively, if housing starts and building permits exceed forecasts during slack economic times, this can give a boost to stock prices. That's because the market's expectation of potentially higher profit growth from greater economic demand can initially be the more influential factor in favor of higher stock prices. That is, for a period of time, it can be the more-dominant driver of stock prices, overshadowing the negative impact of rising bond yields (as discussed above).

How is it calculated?
For housing starts, the U.S. Census Bureau gathers information across all parts of the United States as to when excavation begins for the footings or foundation of a structure. Building permits are a total of the number of housing units authorized to be built by a building or zoning permit, but are not required in all parts of the country. Figures are available on a seasonal and not seasonally adjusted annual basis.

Housing starts and building permits are broken down in two ways. First, by type of building structure:

single-family units,
two-four units and
five or more units.

Second, by geographic region:

Northeast,
Midwest,
South and
West.

How is it used?
Building permits are considered more forward-looking. That's because permits precede starts (in locations of the country where permits are issued). Housing starts are deemed more comprehensive because, unlike permits, housing starts data are collected from all locations of the United States. Together, housing starts and building permits can be used to create near-term forecasts of new home sales and gauge the overall strength of the housing industry.

Of all the structures, single-family units can be the most influential because they account for approximately 80% of the total. Given the forward-looking nature of permits, single-family permits typically provide the most clarity with regard to the direction and strength of the housing industry.

This report can also be used to monitor the sensitivity of consumer's willingness to spend in response to changing interest costs.

How?

If, for example, housing starts and building permits are generally rising in a resilient manner even in the face of higher interest rates, it suggests consumers aren't very sensitive to higher interest rates. Yet at some point, consumers will likely cut back spending if interest rates rise too much. Early signs of such reduced consumer spending can be detected when housing starts and building permits trend lower. This can persuade the Fed to stop raising interest rates. Alternatively, if housing starts and building permits are generally softening during periods of falling interest rates, it likely suggests the Fed would need to cut rates further.

When is it released?
It's released in the middle of the month, usually between the 14th and the 17th, and can be found at http://www.census.gov/ within the "Economic Indicators" section of the site.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation. Data contained here is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed.

(2007-5771)

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