Ketu Desai
By Ketu Desai
While news headlines are focused on tariffs and inflation, the true overwhelming trend is disinflation. This will be driven by a median reversion in housing, structurally lower oil prices, and AI driven wage & service deflation. The 5YR break-even rate (a proxy for inflation over the next 5YRs) is in line with its average coming out of the Great Financial Crisis. Housing will come increasingly into focus over the coming months. In fact, housing has roughly one-third of the weight in CPI which could be a major deflationary force.
The average home price is up over 50% in the last five years, creating the most unaffordable housing market in history. A 20% down payment on a single-family home has risen to a staggering 100% of annual household income. This could very well be one of the biggest housing bubbles in history.
Yet, we are seeing early signs that this bubble is starting to burst. The Case-Shiller Home Price index has declined three months in a row, including during the important spring selling season. According to Zillow’s Home Value Index, prices have reduced 2% at an annual rate over the last three months. In certain states such as Florida, Arizona, California, and Texas the prices have dropped much more viciously.
Redfin reports there are currently 34% more sellers than buyers, the most sellers have outpaced buyers since 2013. Homebuilder supply is 70% greater than normal or the sixth most in history at 9.8 months. Homebuilder stocks are down nearly 20% over the last year. The XLRE (S&P real estate ETF) relative to the S&P is at its lowest since 2009. More than one in four listings got a price cut in June. Investor demand is falling as cap rates are not much above treasury yields. AI will likely be a source of worry for many workers, which will make them more cautious in making any large purchases. The Trump administration as we head into the mid-terms next year will make housing affordability a major priority. Historically, when house prices declined, they continued to drop for many years afterward at a reasonable rate.
The “Big Beautiful Bill” and the AI datacenter boom are the prime drivers of growth; each of which will add approximately 1% to GDP growth for the coming quarters. For now, at least, there is a virtuous cycle. AI will be a deflationary force, which will allow deficit spending to continue and the Fed to cut rates. The market is picking up on it as deficits allow companies to expand the top line, and AI will help raise margins. Revenue is growing at 5%, earnings at 10%, and margins are near all-time highs at 13% on their way to 14% next year.
The S&P is the nation’s retirement and savings scheme. The economy is levered to the stock market with the equity market at 195% of GDP. This is politically important, and we saw from the latest test in April. The public equity markets have a structural bid that totals into the trillions. Invest America recently passed; a plan in which the government funds an account for each newborn that holds the S&P. It formalizes the S&P as the nation’s savings plan for the next generation.
For the generations moving closer to retirement, the nation has a retirement savings deficit between $6.8 and $14 trillion according to the National Institute of Retirement Security. Closing this gap means higher equity allocations. Savings and retirement plans amount to approximately $500bn of inflows each year into the S&P; a number that is only going up. It is politically difficult to allow significant and lengthy drawdowns when a large portion of the population counts on equity markets for their retirement and savings.
Another structural bid comes from S&P companies themselves. They buy back $1 trillion dollars of their stock each year which will continue to expand as the margins do.
Housing unaffordability has led to another structural flow into equity markets. Capital that would have gone for a down payment, is now finding its way into these markets and will continue until housing costs go down.
We are on the verge of another major structural flow into public equity markets. The shift from private market and alternative investments to public market investments for large institutional investors. Private markets boomed after the 2008 Great Financial Crisis, as institutional investors did everything to avoid equity market beta. As a result, the S&P has outperformed private markets on all time horizons without the leverage and better liquidity. Further, private market investors are not getting exits and distributions. With rates no longer zero and increased competition, forward returns in private markets will be more difficult. Harvard and Yale are selling private market investments below net asset value. Despite the AI boom, venture capital has had a negative return over the last three years, while the Nasdaq 100 (QQQ) is up over 100%.
The CIO of the University of California (UC) System said they are ditching hedge funds after decades of poor performance. Jamie Dimon mentioned on JPM’s earnings that, “you may have seen peak private credit.” Private market fundraising has reduced 37% over the last three years. You can tell alternative asset managers are struggling because they are increasingly trying to raise money from retail. As institutional investors start getting their capital back from alternative asset managers, they will put that money to work in the S&P and public equity markets.
Looking forward, the markets will focus on earnings, economic data, the Fed’s Jackson Hole meeting, and the latest from D.C.
Ketu Desai is the Principal of i-squared Wealth Management Inc. (www.isquaredwealth.com), an investment management firm based in New Jersey. ketu@isquaredwealth.com
