Job Growth Slowed in March – But Is it Enough to Halt Hikes? – Jeremy Flint

Bottom Line Up Front

• The March 2023 employment report indicates a slight increase in job growth, but a downtrend compared to previous months.
• Real estate construction and employment slowed, with a high inventory of vacant homes and increased cancellation rates.
• The residential real estate market appears misaligned as increasing builds, decreasing buyer rates, and rising costs indicate a potential disaster.

The US Bureau of Labor Statistics (BLS) dropped its March 2023 employment report today, and it’s a mixed bag.

A Dual Mandate

Remember that the US Federal Reserve has a “dual mandate.” They must advocate and facilitate maximum employment while maintaining price stability (manage inflation).

Source: Federal Reserve Bank of Chicago

Since the Fed’s arsenal is effectively hamstrung, interest rate management is the primary tool to accomplish both policy-wise. Unfortunately, when one of the two priorities is out whack, the other typically see-saw as quickly to compensate.

Skyrocketing inflation meant the Fed needed to raise rates as fast as reasonably possible, which implies a whipsaw effect on the other end (employment) echoed in J. Powell’s 2022 statement that “employers are having difficulties filling job openings, and wages are rising at the fastest pace in many years,” and that “the solution is to bring wages down.” 

That plan bore fruit over the past few months as layoffs spread like wildfire across the tech sector, likely an early precursor to broader unemployment as few industries were buoyed as much by low rates and dirt-cheap debt.

Okay, we’re doubtlessly treading well-worn ground and details you know well. So what’s the March report tell us about the plan’s progress?

March Madness

The top-line numbers indicate little’s changed, as unemployment stays stagnant around 3.5% and job growth jumped slightly more than 200,000 new jobs – although growth is in a downtrend compared to the previous few months.

Source: Bureau of Labor Statistics, The Employment Situation March 2023

So, in effect, we’re seeing positive (in economic terms) movement towards a return toward semi-normalcy and possibly early indications that rate hikes will flatline soon, although unlikely to fall, barring spreading banking crises.

Still, the Fed’s effects lag substantially (look at how long it took for tech layoffs to kickstart), so there’s doubtless more pain ahead for at-risk jobs and your portfolio, considering some see equities still overvalued. Bond markets echoed the sentiment as they forecast another imminent hike, and yields popped almost across the board:

Source: US Department of the Treasury

Many economic reports act as lagging indicators for Fed actions; there are few ways for most traders and investors to gauge their progress proactively or forecast accurately – the most that most of us can do is plan for the worst. One market in today’s report took a pretty big dip, and it’s typically the one lagging the most. This could mean this particular market is in for massive devaluation and losses. Is now the time to jump ship on real estate stocks?

Real News for Real Estate

This month, construction and real estate employment fell by 9,000 jobs, with construction seeing 2,800 losses in nonresidential and only an 800 increase in residential new build positions.

This comes on the heels of KB Homes’ end-of-March report indicating a hefty 38% cancellation rate, which means 38% of their homes under contract saw the future homeowner breaking their obligation on that new build.

Construction, mainly residential construction, lags the most economically – stretched supply chains pushed values up throughout the pandemic as materials were in short supply and mortgage rates saw all-time lows. Still, the correction doesn’t seem to be in yet, only mellowing slightly:

Source: FRED

Reasons for the lag are clear; contracts and material management are forecast well in advance, so any changes in interest rates take multiple cycles to kick in for construction. But that also signifies that the end isn’t close to over. Since contracts push so far forward, many new builds remain scheduled for the year with fewer buyers interested.

The timing misalignment is evident as we see new builds popping to start the year, iterating the typical cycle of an end-of-year slowdown before contracted builds begin in January.

Source: FRED

Costs continue to increase for builders, and the quick move-in inventory count remains high. High inventory means that there are tons of vacant homes already held by developers that incur costs daily as they’re forced to maintain the property. At the same time, they’re spending more to find buyers when buyers are less interested, and sale prices fall.

Source: Zonda

So, we’re looking at a few data points:

1. Construction hires are slowing.
2. The new build rate is increasing.
3. Vacant home (quick move-in) inventory remains high, with more builds on the way.
4. Buyer cancellation rates remain elevated.

Now look at ITB, an ETF comprised of residential real estate builders (DR Horton, Sherwin-Williams) and construction-adjacent firms (Lowe’s, Home Depot):

Source: Morningstar

That’s right. While the S&P 500 is down 9% since last year, the residential ETF is up more than 15% – while facing increasing inventory with fewer buyers that’s all but guaranteed to drop further as mortgage rates push towards double-digits. In part, continued stock growth is due to financial reporting structures that let construction companies recognize revenue when the ink is still wet on the contract, even if cash hasn’t changed hands.

We saw that contracts get canceled, but these builders remain on the hook to complete construction despite losing the buyer. Then, in addition to rising construction costs (inflation, again), they’re on the hook for maintenance while they find a new prospect to take it off their hands.

Markets are misaligned.

Disparate data sets rush toward a collision as builds increase alongside inventory and cancellations while new jobs and new buyer rates slow.

As a lagging indicator, residential real estate might be catching up to reality – when the correction finally hits is anyone’s guess, but the numbers don’t lie.

Unsustainable might not be the right word to describe the status quo, but it’s the first that springs to mind.