Photo illustration by Sarina Finkelstein for MONEY; Getty Images (1); Alamy (1)
By Paul J. Lim
March 16, 2018

Uh-oh. The government reported on Friday that the number of home construction projects that broke ground last month fell 7% versus the prior month.

The report is raising fears that the economy might not be accelerating as much as other economic indicators show.

Why should investors care about a drop in housing starts, if gross domestic product and jobs are all growing at a healthy clip?

There are three reasons:

First, housing — and all of the ancillary spending associated with the purchase of a home, including renovation and remodeling costs and utilities — is a huge part of the economy. It represents roughly one-sixth of total U.S. GDP.

Moreover, “housing starts are a terrific leading indicator of the economy,” says Terri Spath, chief investment officer for Sierra Investment Management. That’s partly because it can take several months for homebuilders to construct a new property. And homebuilders are reluctant to break ground on new projects if they fear the economy may slump later in the year.

Then there’s a third issue. “It’s a reflection of consumer confidence,” says Sam Stovall, chief investment strategist for the research firm CFRA. “Who wants to engage in the biggest investment of their life — buying a house — if they’re worried about losing their job?”

In fact, Stovall looked at the historic data and found that every recession since 1960 has been preceded by a double-digit decline in housing starts.

“That’s why housing starts are so important,” he says.

So Should Investors Start to Worry?

Not just yet. Stovall found that in the months leading up to past recessions since 1960, the average year-over-year drop in housing starts was roughly 25%. The February data released on Friday shows far more modest declines — down 7% from the month prior, and 4% from a year earlier.

So history would say that there’s still a ways to go before investors really need to worry.

But other housing data is also suggesting that there’s real softness in the market, and that could spill over into future housing reports.

What Do Other Real Estate Indicators Show?

Even while investor and business confidence is running high, and jobs are being created at a faster-than-expected clip, housing remains a big question mark for the economy.

In January new home sales fell more than expected — by 7.8% — as the supply of homes for sale fell continued to drop. That pushed the prices of the homes that are on the market higher, deterring would-be buyers. Economists surveyed by Reuters expect supplies to remain tight throughout the year, which could keep a lid on sales growth going forward.

Meanwhile, the news was even worse among existing homes.

The National Association of Realtors reported that sales of used homes fell for the second straight month in January. Moreover, existing home sales fell 4.8% versus the same period a year ago. That’s the steepest annual decline in sales since August 2014, when the economy was still trying to get into gear.

Another possible canary in the coal mine for a housing correction is the stock performance of Home Depot, the country’s largest home improvement retailer.

Despite better-than-expected earnings and sales reports recently, Home Depot shares have tumbled nearly 15% since late January, putting the stock perilously close to bear market territory (defined as a loss of 20% or more).

Why? Investors could view the recent signs of softness in the real estate market as a sign of future headwinds for Home Depot. In other words, Home Depot stock could be a leading indicator of housing starts — which, again, are a leading indicator for the broad economy.

And if investors are right about Home Depot, there could be trouble for the economy in general, and the stock market, later this year.

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