The concept of reversion to the mean says that when you observe a long series of data and then see a meaningful number of data points above or below that mean, you are likely to see a series of occurrences that take you back to that long-term average. In areas as diverse as daily temperatures and activity in the building sector, the long-term average level and trend of activity seem to be somewhat predictive of future outcomes.
This concept is helpful when we must sort through the deluge of economic statistics that become available on a weekly basis. Add to that the predictions and warnings from the presidential candidates, and it becomes downright difficult to maintain confidence in the recovery for which we all waited so long. Here’s why you should.
According to the Bureau of Economic Research, there have been 12 recessions in the post-World War II era. They lasted an average of 11 months. The last recession was longer than any of them—18 months—and left us recovering from a much lower level of employment and housing activity than in previous recessions. As just one example, the NAHB estimates that roughly 2 million households failed to be formed in the last recession, due to millennials continuing to live at home or moving back home.
In order for this pent-up housing demand to be satisfied, and for the concept of reversion to the mean to hold true, we would be due for a longer than average recovery period. The 12 post-war recessions marked the end of expansionary periods that had averaged five years each. Interestingly, the five recessions since 1980 also lasted roughly 11 months but punctuated periods of growth that averaged six years. That’s a year longer than for the post-war period as a whole.
Turning to the current recovery, we see that the single-family housing starts in February 2016 represented a nine-year high-water mark in that category. A general upsurge in demand of that magnitude doesn’t simply dissipate overnight. It is also important to remember that all of this single-family activity occurred in an environment where down payment requirements, minimum credit standards, and other aspects of obtaining a mortgage have improved only modestly over the past several years. Compare this to the false bubble of mortgage activity that fueled the last market peak—and that accelerated the succeeding decline. It’s easy to see that the current housing activity has a much more solid foundation.
On the jobs front, the economy is essentially operating at full employment. All along the food chain, from manufacturers to LBM distributors to builders and contractors, there are challenges finding the right qualified people that are needed at various levels to help companies execute on their growth plans. During the downturn, we frequently received resumes from executives seeking positions and asking for referrals to companies that were hiring. Now, we have virtually none on hand, and the balance has swung around to requests from companies seeking to hire executives or sales managers. Such a tight employment market, coupled with strong consumer confidence and still historically low interest rates, represents a solid support for home building and remodeling activity alike.
So why don’t we hear any of the candidates for office touting the strength and positive aspects of the current economy? The fact is that candidates on both sides of the aisle have too many incentives in an election year not to do so. The Republican Party, in trying to win back the White House, has an incentive to focus on the negative aspects of the current economy so that it can present itself as the solution. However, even the Democratic candidates have an incentive to be negative; they need to show how things would have been even better if they had been in office and, given that chance, just think how great things will be in the future.
The long and the short of it is that normal human incentives drive a negative focus by candidates from both parties whenever we are in an election season. This one is certainly no different.
Taking into account the current macroeconomic picture and examining historical economic cycles, there are many important areas of strength supporting the continued recovery. Perhaps if we choose to skip the evening news once in a while, it will be easier to believe that we are headed for a few more years of strong growth and performance.