While Netflix's (NFLX) 4Q reported about a beat of about one million paid streaming sub adds, the forward guidance was weaker than expected. (It appears that the company's domestic sub adds missed again - by about 200k from the previously and already reduced guidance).
I believe my short thesis, which might be more clearly revealed over the next twelve months, is emerging in a fundamental context (see here) and that Netflix's growth story may be fading:
Here is an updated "free cash flow" table:
Bottom line: Given the large cash burn, the immense and growing content budget, rising population of competitors (and maturing domestic market), the lower value of non US subs and elevated valuation - Netflix shares seem vulnerable.Hereis more from ZeroHedge!
- Kass Diary, 15 Surprises for 2020 Here is David Einhorn's (Greenlight) analysis of his Netflix short, as extracted from his year-end letter:
Netflix (NFLX) - Short
59x P/E on 2020 GAAP estimates, which we believe dramatically overstate the business economics
We have been negative on NFLX's earnings prospects for a long time, and we used the late-2019 bounce in the shares to make it a more substantial investment. For years, NFLX has been an open-ended growth story, where the value of a subscription was considered to be underpriced and bulls could dream about future subscriber totals in the context of the global population. The market celebrated NFLX as the king of a perceived "winner-take-all" (or "winner-take-most") global market for streaming video-on-demand (VOD).
We believe this narrative is finally coming to an end. NFLX is no longer the only value-priced streaming VOD provider. There are now a half-dozen subscription services and in the coming year there will be additional credible entrants with deep content libraries. Not every customer will choose to subscribe to all services, and on the margin, substitution will occur. We believe that new competitors have already hurt NFLX in the U.S. Following an unexpected Q2 subscriber loss and in response to management's apparent optimism, analysts raised estimates for U.S. growth; as recently as September, consensus expected NFLX to add 1.5 million new customers in the fourth quarter. Instead, in October, the company guided to just 600,000. Still, Wall Street cheered the lowered guidance because it was deemed to be "conservative." In fact, the CEO ended the conference call by saying he looked forward to "blowing away" the guidance.
It appears to us that new subscriptions are slowing and cancellations are accelerating. Competition is denting the NFLX domestic story, just as the platform loses its two most popular shows, Friends (in 2020) and The Office (in 2021), forcing management to spend aggressively to create and market binge-and-forget Netflix Originals and stand-up comedy specials, which lack staying power. In response, management has decided to stop disclosing U.S. margins and subscriber totals beginning in 2020.
International subscriptions will continue to grow, but those customers are far less valuable than domestic subscribers, in large part because the revenue per user is lower in international developed markets and much lower in developing markets. Even so, international subscriber growth is now decelerating as well. As NFLX has to compete for subscribers to maintain user growth, the pricing-power narrative should increasingly come undone.
In what appears to be a desperate attempt to achieve international subscriber growth headlines, the company recently launched sub-$4 per month mobile-only plans in Thailand, Malaysia and Vietnam, and in December NFLX began offering up to 50% annual subscription discounts in India. Obviously, the marginal economics on these new subs are... marginal.
To the extent the market sees the NFLX growth story as "busted," there is a lot of downside to the shares. At present, NFLX burns several billion dollars a year in cash and has accumulated a heavy debt load, even before considering future content commitments. Of course, NFLX could service the debt and de-lever by raising equity - but doing so would be a cold admission that the party is over. We doubt management will rush to do that.
* With a less favorable reward vs. risk ratio, banks are less attractive over the near term
I continue to increase my effective cash position and to reduce my gross exposure in this uncertain and elevated equity market.
I have been adding to my short of "everyone's favorite bank stock" - JP Morgan (JPM) .
My JPM short serves as a partial hedge to my three bank stock longs - (WFC) , (C) and (BAC) - which have moved smartly higher in price over the last four months and now possess less favorable upside reward vs. downside risk.
I am now only modestly net long banks - a group that I have championed for some time.
Importantly, I favor this group mightily on an intermediate term time frame and I plan to add back to on a reasonable market drawdown.
Content is king, and ViacomCBS has its fair share.
The stock is trading at a massive discount to peers. If things balance out, the returns will be huge.
An acquisition is possible as the content it has could be used by any of the streaming giants.
ViacomCBS NASDAQNASDAQ is, even in this market, trading for a bargain price relative to its peers and its prospects going forward. With a stable of well-known brands and content franchises, ViacomCBS should come out of the other side of their merger ready to compete in a changing world where content is fast moving away from bundling and towards Direct-to-Consumer.
On a multiples basis, ViacomCBS massively lags the market. The company is valued at ~7.5x forward earnings despite competitors commanding much larger multiples. The closest competitor we can rely on for a multiples based valuation is Lionsgate Films.
Lionsgate, like ViacomCBS, produces and sells content. They also own a distribution arm in Starz. With fewer prospects on the horizon (no DTC, fewer "known" brands to rely upon), Lionsgate trades at a forward multiple of ~15.5x.
If we take that 15.5x multiple and apply it to ViacomCBS' next year's low-end EPS estimate from analysts of $5.91, we get a share price of $91.60. More than a 100% premium over today's price.
An acquisition might also be on the table. From who? Well, anyone that wants to be in the streaming media space and needs a vast content influx. Amazon, Netflix, AT&T NYSE, Verizon NYSE, and even Disney could try their hand at some point in the next few years, particularly as things heat up and content becomes the big differentiator.
Break in. Another delay has been announced in Boeing's (BA) certification of the 737-MAX. Good sale of this name at around $370/share weeks ago! Last sale $311. Lesson learned - when the facts change, we should change.
Breadth has deteriorated - with -700 (decliners over advancers). Under normal market conditions - with both bond yields (-7 bps) and the Transportation Index breaking down (likely indicating economic weakness) - I would, with no hesitation considering the elevated state of market prices and valuations, add to my short exposure. But this is no normal market - as we all know by now. So I do nothing. You can multiply by many - and the above statement and universal knowledge of the artificiality of today's market and the power of liquidity - means that we can probably have a meaningful selloff at any time!
In my "Disconnect Accelerates" post I wrote earlier today:
The disconnect between bonds and the perception that the growth trajectory of the real economy is beginning to accelerate continues this morning.
The yield on the 10 year U.S. note is down by nearly seven basis points (to 1.77%) and not one soul in the financial media has mentioned it this morning.
I now will add today's weakness in the Transportation Index as another conspicuous disconnect.
"Oh, life is bigger It's bigger Than you and you are not me The lengths that I will go to The distance in your eyes Oh no, I've said too much I set it up
That's me in the corner That's me in the spotlight Losing my religion Trying to keep up with you And I don't know if I can do it Oh no, I've said too much I haven't said enough"
- R.E.M., Losing My Religion I have moved from small-sized to "tag ends" in my speculative cannabis basket.
The disconnect between bonds and the perception that the growth trajectory of the real economy is beginning to accelerate continues this morning. The yield on the 10 year U.S. note is down by nearly seven basis points (to 1.77%) and not one soul in the financial media has mentioned it this morning.
* Moving to small-sized in cannabis In the next week I hope to update my fundamental view and share price outlook on the cannabis space. I had expected the stocks to bounce in January, after the tax selling period of late 2019 abated. To some degree, we have seen a recovery in a number of the stocks. Most noticeably, (CGC) 's has risen from under $14 to over $25. One of my speculative holdings, (HRVSF) has increased from $2.20 to over $3.50 (a gain of almost +60%). The industry continues to face a number of supply/demand and other challenges over the near term but has plenty of opportunities over the intermediate term. I have given the space a full three weeks of January ("effect") trading and I want to continue to reduce my portfolio's aggregate gross and net exposures. While I still regard the cannabis space as having an excellent longer term upside reward vs. downside risk, the transition to fundamental improvement, supply/demand balance and a return to profitability are likely to take longer than I initially expected. (In terms of time frame I suspect we will have to wait to 2021 to see the stocks begin a consistent and meaningful move higher). So after the January bounce and even though the stocks are still dramatically below their early 2019 highs, I am now moving down from medium-sized to small-sized in my speculative basket of cannibas stocks. In addition, I am eliminating my CGC long (at over $25/share) and taking the stock off of my Best Ideas List. (I was wrong on the name but fortunately I was quite lucky to have doubled down under $15/share).
Position: Long CRON, HRVSF, GTBIF, CRLBF, CURLF (all small now)
I remain laser focused on market breadth. In the early going, breadth is negative 2:1 but I am seeing some of the market leaders rallying hard from the early weakness.
* Apple is a symptom, not the cause... * As I rant my way to the start of a new trading week!
Apple's (AAPL) shares are a metaphor for the market (and how liquidity and the machines and algos can impact our markets). In the last 12 months nearly the entire move in the stock was embraced by a PE multiple expansion of 90% (see Figure 11, below). The multiple expansion was not driven by accelerating growth. Indeed, cash flow (and revenue) have been stagnant for five years (see Figure 12, below).
This is also what has happened to the S&P Index. Limited revenue growth, no operating income growth, some growth in EPS (only driven by buybacks and the resultant share count shrinkage). And then a massive PE multiple expansion - even in the face of the aforementioned slowing in revenue and operating income growth we have multiples and a number of traditional metrics at or near historic highs.
We are somewhere in an advancing and maturing new normal or investment backdrop that many, including myself, find disquieting. Remember, it is normal for price earnings multiples to expand when growth expands or when companies are at trough earnings, but the market realizes normalized earnings are higher and gives credit for that.
Apple's 90% PE multiple expansion last year absent revenue or cash flow growth for five years is an extreme example but there is a similar phenomenon, though not as extreme, for the markets -- massive multiple expansion (and to high levels of absolute multiple as well on peak earnings no less), without sales or operating income growth.
As seen in the final chart in this post, below, (in its extreme melt-up condition) a company like Apple can end up with a market cap that is now as large as the entire market capitalization of the total Australian equity market!
To be clear my point is about the entire U.S. equity market, not just Apple.
Apple is a symptom, not the cause.
Moving on...
A traditional economist would respond by saying something like "fundamental forces are creating high saving relative to investment opportunity and this leads to bidding up of existing assets" and "reserves that pay interest are a lot like floating rate treasuries so we don't see why QE should impact asset prices."
Let me briefly address each of those arguments:
Our starting point is that over the past four months, the correlation between the Fed's balance sheet and the S&P has been 95%! That is too high to be a random event. It is happening. We could end the whole conversation with that single data point.
As far as the savings glut argument is concerned, that should effect all markets geographically relatively equally, and all assets relatively equally. Clearly it hasn't. For example, (and as mentioned above), Apple's market cap catching up to the total market cap of the Aussie Market in a very short period of time. That move is 100% coincident with when QE was started in the U.S. Australia did not embark on QE. Even though Aussie assets should also benefit from a global savings glut, ex the QE that market did not rip up, and Apple out of nowhere caught up!
- (Side note): The impressive thing about Apple is they actually earn 60% of what the entire Aussie equity market earns. That has been the case for years, and Apple's market cap remained well below that of the entire Aussie market. However, the Aussie market has also grown earnings the last few years, while Apple has not. I would argue a diversified stream of earnings that is growing should get a higher multiple than a single source of earnings that is not growing. Regardless, 90% PE multiple expansion for Apple out of thin air and for the first time ever equaling the market cap of the ASX, and the U.S. market ripping post QE with a 95% correlation to the Fed's Balance sheet make a powerful point. We had QE, Australia did not.
As far as the argument that QE and excess reserves should not effect asset prices is concerned, I agree and disagree. Mechanically, I do not think that it should effect asset prices. But there may be something going on mechanically that is not well understood or well disseminated or something goofy is going on behind the scenes.
More importantly, there is a powerful moral suasion argument that matters equally. If people believe QE drives up equity prices, then it will drive up equity prices. The moral suasion aspect of QE cannot be ignored. It is irrelevant if there is nothing mechanical going on. If it is happening, it is happening. Doesn't matter why. It is irrelevant if heroin gets you high because it acts mechanically on your brain or you just think it does and there is a powerful placebo effect. High is high. Addicted is addicted. The data is the data. 95% correlation between equity prices and the Fed's balance sheet.
- This is why Tepper and others scored so big...they rode the tide and the tide may still have a long way to go. Meanwhile the bears keeping crying wolf (bear) and it never happens. If the Fed goes lower on rates, even hints at negative rates with more liquidity injected post the election, the market rips, asset prices are going higher and their is a bigger credit expansion. With the benefit of hindsight, rather than screaming about the downside risks in which it is hard to find the trigger events, some of the bears should have accepted that it is a new market construct and that our task to learn and figure out how to be successful.
- Yes...and what happens when you have QE6 and QE7?
- The reality is the liquidity the Fed injected in October to calm the repo market was effectively Q5. Both perception wise, and the sheer size of the balance sheet additions they made according to the recent data. Plus the three rate cuts. There is simply no way of not acknowledging that and factoring it in accordingly
- The music is still playing so keep dancing?
Economists tend to believe one thing, and they may be theoretically correct. However, the people (and the people that programmed the machines) moving the actual money believe another thing. The people and machines moving the money at the end of the day are what matter.
A good example is stock charts - which some have mistakenly refused to acknowledge, discarding them as trivial and irrelevant. Head and shoulders pattern, crossing 50 and 200 day moving average, relative strength, double death cross, all these are theoretically silly and meaningless technical indicators to some as they have nothing to do with a business or its future earnings power. Many (including myself) have frequently ignored them, to our detriment over the last year. Even though they are irrelevant in academic theory, enough people believed in them for them to matter. All these indicators that in an academic/intellectual sense are considered meaningless to many - in a practical sense turned out to be meaningful. Then all the computer trading came along. The computer guys figured out this stuff was a meaningful variable, and that increased the impact of something that was academically irrelevant, even more so. Again, I and others were stubborn, ignoring them to our detriment. Even though that stuff shouldn't have mattered, it really mattered. And got more influential with the advent of program trading.
- (Side note II): People often tend to ignore things to their own detriment. Like me. Confirmation bias. Economists are you listening? I know you have been the smartest guys in the room your whole lives, but what you believe in theory is not always right in practice. Look at the evidence out there in the real world. It is important to be able to realize when you might not be right. The smarter you are, and the more right you have been your whole lives relative to others in the classroom, makes it harder to admit when you are wrong. I get it. But get over it.
Same thing with QE. Whether it should matter or not on an intellectual/academic basis doesn't matter. What does matter is that for all practical purposes it does. And the computers are hundreds of times more involved in the markets now than they were when I started my investment career decades ago. The computers pile in right along with and in excess of the humans. And that is how Apple's PE multiple (and every other stock of that nature) expands 90% all of the sudden on nothing.
To conclude...
Here is some more interesting food for thought. Most economists agree with the notion that QE does not affect asset prices, but not all, including the Dallas Fed President in this article.
Since I started working as a housing analyst at Kidder Peabody in the 1970s, the investment game has had many permutations (and style changes). The reality is that it has been forever in a state of flux and the successful are those that adapt and learn from the changing conditions.
There is no question to this observer that, more than in any time in investment history, the changes have accelerated materially in the last decade - requiring us to lose our dogma and to adapt from an investing standpoint.
By now, we all have a good idea of why the market has risen to all-time highs, for as Warren Buffett once said, investment vision/wisdom is always 20/20 when viewed in the rear view mirror.
The markets will forever be challenging.
But (I am also equally confident) that, in the intermediate term, asset prices untethered to reality are still never a good thing.
For those who try to predict where markets will be 12 months from now, however difficult and silly a guess, throw out all your models and historical references and just measure the mood at Davos this week and do the opposite. It worked perfectly the last two years as each year ended exactly opposite of the Davos mood in which it began.
We've been looking at the elevated market sentiment over the past few weeks in a variety of metrics. Here is another one from Citi which is published each weekend in Barron's. According to Citi, "The panic/euphoria model is a gauge of investor sentiment...Historically, a reading below panic supports a better than 95% likelihood that stock prices will be higher one year later, while euphoria levels generate a better than 80% probability of stock prices being lower one year later." The index currently at .34 is just below the .41 which indicates euphoria according to Citi.
The virus in China has everyone remembering SARS again which hit that region between November 2002 and July 2003. Wikipedia said there were about 8,000 cases where 774 people died. From late November 2002 to late April 2003 the Hang Seng in particular fell 17%. This was a panic move as the whole region was in its own personal panic that drove the decline in confidence which in turn affected the economy. I don't want to downplay the current affliction but it will get resolved sooner rather than later and the actual economic impact should be negligible. That reality though didn't stop all Asian markets except Taiwan to trade in the red with the Shanghai comp in particular down 1.4%, the Hang Seng down twice that and the H share index lower by 3.2%. Copper traded down by 1.6%, lower for a 4th day and all the travel related names got hit hard.
The BoJ met today but did nothing as expected. Other than eventually tightening, if that is even possible for them, there is really nothing left for them to do on the easing side other than completely nationalizing all the bonds and stocks outstanding. They are though about half way there. Here are some quotes from Kuroda who seems very intent on just sitting tight and has no appetite yet for tightening even if the global economy is seeing a bottom in some eyes. "Progress in US/China trade talks and Brexit have led to an improvement in risk sentiment, pushing up stock prices and long term rates in many countries...While risks surrounding global growth have subsided somewhat, they remain large."
On the elusive goal of achieving a mistaken 2% inflation rate and all the damage done to the Japanese banking system, Kuroda said this: "It's true the BoJ must be mindful of the impact prolonged ultra low rates could have on financial intermediation. But the benefits of our policy still exceed the costs. The BoJ will continue to pursue powerful monetary easing to achieve 2% inflation."
On when they might decide to stop easing, "If the economy accelerates dramatically, there could be some debate. But for now, it's appropriate to maintain our current policy stance. Various overseas risks remain, so the current monetary policy with an easy bias will be sustained for some time."
JGB yields didn't budge, the yen is up a hair while the Nikkei fell .9% along with all other Asian markets. Kuroda and the BoJ have been rendered completely impotent in generating faster economic growth via the tool of monetary policy.
With respect to easier comps versus the same month last year and maybe, just maybe, a sign of global trade stabilization, South Korea said its exports in the first 20 days of January fell just .2%. That's the least negative since December 2018 and its comp was a nearly 15% decline in January 2019. Semi exports were still very soft, falling by 17% y/o/y but not as bad as the 20%+ we've seen for months on end. The Kospi though, on the virus fears, fell 1%.
Cooling some expectations that the BoE would cut interest rates on old economic data, rather than waiting for the response to the election, the jobs data reported today was better than expected. For the 3 months ended November 208k jobs were created, well more than the estimate of 110k. The unemployment rate held at just 3.8%, the lowest since 1975. Amazing that we're debating a rate cut from just .75% with that stat. Wage growth was also pretty good, rising 3.4% y/o/y ex bonus' as expected. As for the December jobless claims figure, they totaled 14.9k, the same pace seen in November. On the good data and maybe the possibility that the BoE does show some patience has the pound higher and the 2 yr gilt yield up by 1.5 bps after last week's 10 bps drop. The BoE should just sit there and do nothing.
Finally with respect to the data, Germany's ZEW January investor confidence index on the German economy improved to 26.7 from 10.7 and that was much better than the estimate of 15. Current conditions rose 10 pts m/o/m to -9.5, 4 pts better than forecasted. ZEW said the "recent settlement of the trade dispute between the USA and China" was the main reason for the confidence lift as "This gives rise to the hope that the trade dispute's negative effects on the German economy will be less pronounced than previously thought." That hope better be realized this year. The main caveat, "Although the outlook has improved, growth is still expected to remain below average." The estimate for the eurozone is 1% growth in 2020. German bund yields aren't responding as the IFO number is more relevant for markets.
We are reducing our market and offensive sector views from positive to neutral given the extreme overbought condition and high level of optimism toward equities, especially in the Information Technology sector. We have been recommending an aggressive field position since emerging from the third mini-recession and market plunge late in 2018, and now believe it is time to take offense temporarily off the field. The S&P 500 (SPX) is up 33% since the end of 2018, led by the Info Tech (56%), Communication Services (37%), Industrials (31%) and Financials (30%) sectors. Our view since mid-November has been to hold current equity exposure and stay overweight in Info Tech, Financials, and Industrials given our core fundamental thesis and the upside momentum, but as seen in Flying Smart, we have not wanted to add new exposure until the intermediate overbought condition and investor optimism have been reduced. The market and Info Tech sector have reached a point that warrants a change in view - even if it is temporary.
Positioning for "a" peak but not "the" peak. The weekly Relative Strength Index (RSI) for the Information Technology Sector has reached a historically extreme level of 82 for only the fifth time since 1990 (Figure 1). The prior four occurrences of such an overbought level brought an almost immediate peak, followed by a median 13.75% drop over the ensuing weeks/months (Figure 2). It is important to note that none of the occurrences were anywhere near "the" peak, but each was nasty enough to warrant a more neutral position until the sector corrected. Even after the 1995 occurrence that saw a very brief initial pullback, you could have bought the sector at a better price in the early 1996 market melt. This really isn't that complicated a call - Info Tech has led the market to a position that is excessive and has generated temporary pullbacks in the past.
Figure 1: History points to a temporary correction in Info Tech.
Past performance does not predict future results
Figure 2: ...that can get a bit nasty.
Our fundamentally bullish case in 2019 is now the consensus view. Throughout most of 2019, many feared the trade war, political drama, and geopolitical events like Brexit could cause a recession and dramatic downside in the equity market. Although not popular for most of last year, our upside case for the market since the end of 2018 has been based on: (1) The Fed's dovish pivot and low inflation meant it would remain highly accommodative, (2) our credit market indicators showing increased money availability, (3) solid domestic growth based on full employment, high confidence, and a demographic tailwind, and (4) a positive inflection in global growth from a historically weak level. These positive influences remain in place but are now considered likely by most, and have already been discounted over the near term given the upside. We will look to rotate more offensively again on any meaningful pullback in the market as long as our positive fundamental core thesis remains in place.
Watching Davos and EPS for potential correction catalyst. This week kicks off the World Economic Forum in Davos where anyone related to managing monetary policy (everyone) is going to have to answer nonstop questions about how the Fed's dovish stance is creating an unhealthy ramp in risk assets. Fed-speak during periods of low volatility can provide a catalyst for an unexpected drawdown - as evidenced by Alan Greenspan's "Irrational Exuberance" speech in Japan on Dec. 5, 1996.
In addition, the EPS reporting season for Info Tech kicks into high gear this week beginning with IBM Tuesday. According to Refinitiv, the Info Tech sector is expected to have flat EPS for the quarter with only 0.6% growth vs. the prior year. Given the equity market's run higher, the historic overbought condition of the market-leading sector, the new more positive consensus fundamental view highlighted above, and a trailing 12-month valuation of 20x for the SPX, we think the market is a tinderbox looking for a spark.
Summary: Pulling in the horns until excessive overbought and investor optimism are corrected. History has shown that either a long-duration consolidation period or a nasty pullback can help relieve market excesses, and we have evidence the move higher in Tech has created the type of environment that generated temporary corrections in the pre-dotcom era. Again, our fundamental core thesis and history do NOT suggest the market is on the precipice of a major market decline, but our four key tactical indicators -- coupled with the close proximity to our 2020 SPX target of 3,440 and the history of such a ramp in the market-leading Info Tech sector - point to an environment ripe for a temporary but potentially nasty drawdown that should provide excellent entry point into equities. We would be sector neutral with the intent of putting offense back on the field pending a resolution of the extreme overbought level of the major market indices.
Danielle DiMartino Booth asks if there is a disconnect in the housing data:
At 16.5%, December housing starts exceeded expectations by the second-largest extent on record; while some of the outsized gains were attributable to one of the warmest Decembers on record, the stronger housing starts should still boost first- and second-quarter 2020 GDP
Housing starts feed the more familiar Residential Real Estate GDP input; the "new permanent structure category" is the broadest, encompassing starts, followed by home improvements/renovations and existing residential real estate transactions by realtors
December's strong housing starts conflict with weak Construction openings in November's JOLTS report; the BLS' omission of seasonal adjustments in the series, a clearly seasonal sector, help bridge the apparent disconnect
Four-day work weeks can require a jump start akin to hot-wiring a car for a quick getaway. Sarcasm alert: For those not looking to change professions a la "Grand Theft Auto," we assure you hot-wiring know-how is vital. You can't get ahead in the business without knowing how to start a car without its key. It helps to be familiar with a particular vehicle's electrical system. That said, brute force can be used to bypass the ignition lock. Simply smash the key mechanism to reveal the rotation switch operated by the key's tumbler. Best to know that this methodology only applies to cars produced before the mid-1990s, a.k.a. classics, so choose wisely.
Of course, we'd never advocate for absconding with someone else's personal property, or any other illegal act, for that matter. But in that we have your attention, we thought we'd share a backgrounder on the hard-wiring, not hot-wiring, of housing starts into the residential investment outlook.
What prompted this introspection, you ask? Last Friday's December housing starts of 1.6M blew past market expectations of 1.38M by the second largest amount on record, or 16.5%. The only other month in the same zip code was February 2009, four months prior to the end of the Great Recession, when starts surpassed expectations by 26.9%.
Categorize housing starts as a primary input to U.S. GDP - the data feed directly into private residential construction spending, which in turn determines "Permanent site residential structures." Both single-family and multifamily housing starts fall under this designation, the largest slice of the residential pie at 43%, versus a 34% share for home improvements/renovations and 22% for residential real estate transactions by realtors.
If you took the December upside housing starts surprise at face value, you might think fourth-quarter GDP would be the only beneficiary of the gain. Though we demur whenever possible from falling back on the weather (every economists' favorite excuse when their forecast fails), December was nonetheless one for the record books in which it was impossible to not break ground.
Better put, Santa never had it so easy, Christmas Day in the country's midsection was unprecedented with Chicago, Erie and Grand Rapids at 61, Cincinnati and Kenosha at 63, Indianapolis and Louisville at 65 and St. Louis at 69. Moreover, snow only coated 25% of the country compared to a 38% norm and a recent high of 58% in 2009 (are recession years unusually cold?)
Even so, we expect material follow through in housing strength. Single-family filters through to residential construction spending over 12 months post-groundbreaking. In December, just 16% of the new single-family homes constructed were counted. That would leave 84% of the project to be completed. By the third month, more than half of the work, 56%, is in the till while by the sixth month, the home is 91% completed. The builder easily skates to the finish line.
In short, month one's housing starts input is not exclusive to that month. The December 2019 surge will have a lingering beneficial effect with the highest concentration of activity falling in 2020's first and second quarters, not the fourth quarter of 2019.
This distinct strength conflicts with the weakness broadcast from the Construction sector in last Friday's Job Openings and Labor Turnover (JOLTS) report. On the surface, the collapse in Construction job openings begs the question, could the collapse in future labor demand be an indication of commercial real estate weakness outweighing residential real estate's strength? Or did Opportunity Zones that had to be funded by year-end 2019 create an artificial surge in housing starts? We'll opt for a more technical and less fundamental explanation.
The Bureau of Labor Statistics (BLS) footnoted JOLTS Construction job openings as such: "No regular seasonal movements could be identified in this series; therefore, identical numbers appear for the unadjusted and seasonally adjusted series." The seasonally adjusted data are, in fact, not seasonally adjusted (NSA).
An unprecedentedly shallow construction labor pool also could be eschewing job openings. Some 46% of small businesses cite "quality of labor" as their top business problem. The ISM Non-Manufacturing survey noted Construction labor has been in short supply for 45 straight months; Construction Subcontractors have been under-supplied for two years. These anecdotes shed light on how tight the sector is sporting a seasonally adjusted Construction unemployment rate below 5% for the longest period on record; the past two cycle lows were north of that bogey.
Despite the BLS' disclaimer -- that the drop in Construction job openings is not seasonally adjusted -- there is undeniable seasonality in the series. A simple comparison of Construction job openings to NSA construction employment from either the payroll or household surveys illustrates the tight connection (outside southern California, how could construction not be seasonal?). Maybe BLS statisticians need a crash course in hot-wiring their seasonal adjustment program.
