Home Depot and the Housing Market’s Leading Indicators

The performance of home improvement retailers such as Home Depot (HD) and Lowe’s (LOW), and that of suppliers including Masco (MAS) and Mohawk (MHK), is significantly influenced by the  housing (XHB) (ITB) market. Housing starts and permits are leading indicators. They respectively measure the levels of new residential construction actually started and the number of permits applied for. These indicators are valuable economic data points for forecasting demand for home improvement products.

Other key housing-related indicators include new and existing home sales, home prices, and the growth in private residential construction investment in the GDP (gross domestic product). These help Home Depot and its peers assess the level of new housing demand and forecast demand for their own products. Housing demand, in turn, depends on what stage the economic cycle is in, employment, and incomes, as described in the previous parts of this series.

After rising 11.9% in 2013, real private residential investment was up by just 1.6% in 2014. The recovery in the housing market has been slow. Although rates have been at or near historical lows, a lack of first-time homebuyers, tighter lending standards, and a low supply of entry-level homes are some of the factors hindering growth.

As a result, housing starts and permits haven’t shown steady traction. Housing starts plunged by over 17% to 897,000 units in February, 2015, their sharpest drop since December, 2012. Having said that, poor weather in February may have affected numbers somewhat, since building permits were up 3% month-over-month.

Home price levels also influence the health of the housing market. Rising prices tend to imply higher housing demand relative to supply and vice versa. In recent years, home prices, particularly in major US cities, have shot up. That’s partly due to higher investor demand in major cities and partly due to a lower supply of new homes.

Home Depot is positive about housing market prospects. The US economy is in expansion mode. Private residential fixed investment as a percentage of GDP is short of its historical 4.6% average. Nearly 67% of US housing stock is over 27 years old. And, while US home prices have risen, they’re still short of their 2006 peak.

The next article discusses the company’s guidance for fiscal 2016.