A cursory glance at the U.S. housing markets suggests that the worst is over and the recovery is on its way. Both existing and new home sales are above their January cyclical lows; housing starts and permits have turned up in recent months; home price depreciation has slowed and mortgage rates remain near historical lows. But before we declare victory, we must consider the possibility of a false start.

Existing home sales rose 2.4 percent in May to an annualized 4.77 million units and have posted two consecutive month-over-month gains for the first time in almost two years. But there are two factors that cloud the recent sales performance. First, about 45 percent of existing home sales in recent months have been foreclosure sales. Foreclosure sales are usually sold at market discounts and a meaningful percentage of them are acquired by speculative investors. This is not exactly the type of sales boost you would like to experience at the start of a recovery. In addition, existing home sales have surged recently in California due to the state’s home buyer tax credit which has now run out of funds.

New home sales posted an annualized pace of 342,000 in May and have held steady around that number since the beginning of this year. The fact that new home sales have not retreated this year is a positive outcome. However, being stuck near a cyclical low for almost a year is nothing to write home about. To date, there is nothing in the new home sales numbers that suggests recovery.

Similarly, housing starts posted an annualized pace of 532,000 units in May, up from April but still down significantly from a year ago. In fact, if we remove multifamily starts (which are not correlated to single family home sales) from the total starts number, we find that single family starts in May were 41 percent below it’s year ago levels. Further, the National Association of Homebuilder’s index fell to 15 in June from a 16 in May; so even homebuilders are losing some confidence in the future.

Turning to home prices, it appears that we are forcing ourselves to find something positive in the recent numbers. The Case-Shiller 20-city home price index for April was down 18.1 percent year over year, compared to an 18.7 percent year over year decline in the March index. Most of the headlines cited the slowing of home price depreciation as an indicator that home prices are beginning to stabilize. One would think that we would need three to four months of falling price declines before contemplating price stabilization. Further, there is little evidence that the flow of foreclosures is letting up. A steady dose of foreclosures continues to add to inventories, exerting downward pressure on home prices. At present, there is little evidence that home prices are on the path to stabilization.

Perhaps the largest obstacle to a housing recovery is the U.S. economy. It has become quite clear that mounting job losses are contributing to rising foreclosures and mortgage delinquencies. According to Realty Trac, almost 1.5 million homes have received a foreclosure filing in the first five months of this year. And according to Moody’s Economy.com, defaults are on track to hit 3.5 million this year. Further, foreclosures in process surged 22 percent in the first quarter of this year according to a report released by the Office of the Comptroller of the Currency, OCC and the Office of Thrift Supervision, OTS. How can we experience a housing recovery when delinquencies and foreclosure filings are on the rise?

The employment numbers were not pretty in the latest monthly release. There were 467,000 job losses reported in June and the unemployment rate rose to 9.5 percent. We have now lost 6.5 million jobs since December 2007 and most economists are expecting to lose another 1 million jobs in 2010. Not exactly a favorable backdrop for a housing recovery.

As long as foreclosures continue to meaningfully add to housing inventories, there will be downward pressure on home values. As a consequence, more and more homeowners will lose wealth and find their mortgages underwater (where the value of their loan balance is greater than the value of their home). Homeowners underwater are no longer candidates to trade up to purchase larger homes, inhibiting housing demand. Further, new home buyers continue to have difficulty obtaining mortgage financing due to tight credit conditions.

On a positive note, the Obama Housing Affordable program is making some progress to prevent future foreclosures. Over 20,000 loans have been refinanced and the program has now expanded to permit 125 percent loan-to-value ratios which will hopefully increase the number of households that will qualify for refinancing. In addition, the Obama administration has proposed a comprehensive package to reform the U.S. financial markets. Hopefully, this will lift investor confidence and loosen credit a bit.

On balance, it is clear that the housing sector has a difficult road ahead if it is to get on to the road to recovery. We have experienced several false starts to a housing recovery in recent months and will probably experience more in the future. My advice is to exercise caution and skepticism to future reports on housing activity and demand to observe a steady positive trend in the data before declaring victory.