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Why income growth is still sluggish, negative for homebuilders

Personal income is part of the Income and Outlays Report put out by the Bureau of Economic Analysis

Personal income is the income a person receives from all sources. This includes wages and salaries, government transfer payments, other labor income, proprietor’s income, and rental income. Increases in personal income drive consumption, which accounts for roughly 70% of the U.S. economy. Personal incomes dropped precipitously during the Great Recession, and it took over two years for incomes to return to their previous highs.

Personal IncomeEnlarge Graph

Highlights of the report

Personal income increased $45.4 billion, or 0.3%, to reach $14.1 trillion in June 2013. Disposable personal income (DPI) increased $33.6 billion, or 0.3%, from May. If you look at the chart, you’ll see a lot of volatility around the end of last year. The large jump in incomes in late 2012 and the subsequent drop in January are due to the acceleration of bonuses and personal dividends to 2012 in anticipation of increased taxes in 2013. It seems like tax noise is behind us.

Wages and salaries increased $38 billion in June, compared to an increase of $19.1 billion in May. Proprietors’ income decreased $21.7 billion in June, compared to a decrease of $19 billion in May. Rental income increased $1.5 billion—about the same increase as May.

Implications for homebuilders

Homebuilders are sensitive to the general economy, particularly the job market. Sluggish income growth isn’t what they want to see. From 2000 through 2008, personal incomes increased 0.4%, so we’re a little below the normal trend.

Overall increases in business activity and consumption are starting to drive more business for homebuilders, like Lennar (LEN) and KB Homes (KBH). Housing starts have been so low for so long that there’s some real pent-up demand that will unleash as the economy improves. The persistent story for homebuilders is optimistic: household formation numbers will be a wind at their backs.

The return of the homebuilding sector can set up a real virtuous circle for the economy. A major reason why the recovery has been tepid so far has been the lack of construction, since construction is a big employer. Historically, homebuilders were the first to recover after a recession—construction and homebuilding usually led the economy out of a recession. This time around, that didn’t happen because of the shadow inventory, which meant that economic growth was more tepid during this recovery. That appears to be changing.

Homebuilders generally reported strong second quarter earnings, but we’re starting to see the first-time homebuyer back away as rate increases start to bite. Builders with a lot of non–West Coast exposure and inventory at the lower price points noticed the decline in traffic the most, specifically PulteGroup (PHM) and Beazer Homes (BZH). On the West Coast, however, things are still red-hot. The only remaining major builder to report is Toll Brothers (TOL), and it’s luxury-focused.

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