Housing Is the Financial Cycle: Evidence from 100 Years of Building Permits

Abstract
Housing market conditions are often used as a leading indicator of real business cycles in the macroeconomics and forecasting literature. Does the housing market also lead the financial cycle? We address this question by leveraging deep learning OCR techniques to create a new hand-collected database spanning a century of monthly building permit quantities and valuations for all U.S. states and the 60 largest MSAs. We show that the option to build embedded in permits renders volatility in residential building permit growth (BPG) a strong predictor of aggregate and cross-sectional stock and corporate bond return volatility, even conditional on corporate leverage and firms' exposure through their network of plants to other localized physical risks like natural disasters. Cities with more elastic housing supply consistently predict stock market downturns at 12-month horizons, resulting in new trading strategies to hedge against overbuilding risk.