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Shallow Concerns About Shadow Capacity

NEW YORK (CNNMoney) — There is a growing glut of foreclosed homes threatening to hit the market over the next couple of years, potentially delaying any recovery. -January 20th, 2011

There were high hopes that 2012 would be the year when the housing market, battered by the explosion of the real estate bubble, would finally begin to recover. But any good news on the housing front has quickly been followed by negative news. -April 10th, 2012

β€œThe shadow inventory is quickly being worked off and is no longer a significant weight on the housing market in most parts of the country.” -August 23rd, 2013

In 2010-2012 all we heard about was shadow inventory in housing, about how at best it would hold back the recovery and at worst come flooding onto the market and cause a second leg down for housing. Those fears never really materialized. Since late 2011 most of the homebuilder stocks have tripled or more, owners’ equity in real estate has skyrocketed, and home prices have rallied strongly in many distressed markets.

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We’re hearing the same thing today in the labor and industry capacity markets. A still poorly-understood decline in the labor force participation rate. Capacity utilization that supposedly doesn’t account for mothballed factories that could quickly and cheaply come back online. Proof that capacity shortages are unfounded because measures of inflation remain low, and because loan growth is subdued.

I’m just not a believer in those factors. We saw in housing that the shadow inventory threat never materialized — some of it came back onto the market in drips and drabs. Some of it was in such rough shape from neglect that it remains vacant or needed serious upkeep. I expect it’ll be the same story with people and capacity that left the labor force and productive sector over the next few years.

What we know: jobless claims are back at normal levels:

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Job openings / layoffs (from the JOLTS survey) are at all-time highs:

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The “quit rate” (people who left jobs voluntarily, from JOLTS) of accommodation and food services workers (think McJobs) appears to have hit escape velocity in recent months:

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Capacity utilization (blue line, left) is near the highs of the last cycle, even while private residential + non-residential investment as a share of GDP remains at recessionary levels and households have spent the past 5 years reducing their debt levels:

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You are going to read more and more stories about industries and geographies that are scrambling for resources. Building new capacity has a long lead time — years — so it’s too late to add new office buildings and housing before 2016-17 if demand turns out to be more than expected this year. Just ask UPS what happens when you get surprised by demand — you end up paying extra to fill it.

One last picture — here’s some recently-acquired shadow inventory in my neighborhood. Don’t let the shadow narrative sucker you into thinking the output gap is bigger than it is. You, and the short-term bond market, may be in for a rude awakening.

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