Stocks Hot, Housing Cold

Led by the technology sector, equity markets touched new all-time highs this week. This rally was largely driven by a much-needed stabilization in interest rates following their recent surge. Notably, this is the first all-time high the S&P 500 has registered since the 10-year Treasury rate eclipsed 5% in mid-September. A string of "less-hot" economic data released over the past week has significantly diminished market expectations that the Fed will hike rates again at the upcoming October meeting, which has allowed the many investors to breathe a sigh of relief.

While the Fed Funds rate attracts headlines, longer-term interest rates generally have a much greater impact on economic activity. The fallout from higher rates is most visible in construction activity and housing markets. Year-to-date, total construction spending has fallen 3%, despite the monumental surge in data center investment.

As the chart above illustrates, year-to-date construction spending is a tale of two economies. Data center investment is absolutely booming, up a staggering 68%. This explosive growth is single-handedly masking otherwise weak activity across the rest of the board. Traditional foundational pillars are sliding backward, with Office construction down 11%, and both Retail and Housing down 7%.

At the local level, political sentiment around data centers is becoming increasingly poor. Communities and municipalities are pushing back against the perceived strain these facilities place on local power grids. However, policymakers must tread very carefully. Given the profound weakness in commercial and residential development, a regulatory slowdown or moratorium on new data center builds could potentially pull the rug out from under the construction industry, with a meaningful and negative impact on the broader economy.

On the housing front, mortgage rates have recently pushed north of 7.25%, marking the highest borrowing costs in many years. In a normal economic cycle, a surge in rates this aggressive would crush housing prices as demand evaporates. Instead, home prices are stubbornly refusing to fall nationwide. Many homeowners, tightly clinging to sub-3% pandemic-era mortgages, are refusing to sell. This "lock-in" effect means housing activity and turnover have taken yet another leg lower.

Because prices have largely stayed elevated while financing costs have skyrocketed, affordability has plummeted. As shown below, the home price-to-median household income ratio is hovering just below 7. We are currently sitting at levels that match or exceed the absolute peak of the mid-2000s housing bubble. When you combine this historically high price-to-income ratio with 7.25%+ mortgage rates, affordability is undeniably the worst we’ve seen in a very long time.

Yet, despite these clear economic strains on real estate and construction, stock markets continue to forge ahead into record territory. It is important to remember that the stock market is not the housing economy. Housing-related equities represent a mere 2% to 3% of the S&P 500 index. Meanwhile, the true workhorse of the overall economy—consumer spending—continues to chug along at an enviable growth rate of over 3%, with retail sales growth performing even better. As long as solid labor markets keep the consumer engine humming, broad equity markets can comfortably decouple from a frozen housing sector and power the economic recovery forward.

Takeaways for the Week

• The S&P 500 registered its first all-time high since August this week
• Rates have surged, adding pressure to construction and housing markets
• The stock market is not the housing market. Consumer spending and the labor market remain healthy

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