Observations on the Economy and Housing Market

At a cursory glance, the U.S. economy is improving, while the status of the housing market remains uncertain. President Obama and his Administration appear to be under a great deal of criticism for his mishandling of the economy, so he placed great rhetorical emphasis on fixing the economy during his State of the Union speech. Federal Reserve chairman, Ben Bernanke finally got re-appointed for another four years, but not without opposition by a select number of Senators, accusing him of favoring Wall St. and large financial institutions during the crisis bailout last year. Their eyebrows were justifiably raised when these companies doled out millions of dollars in bonuses to employees after they were given billions of dollars in bailout money from the government via taxpayers.

More observations… After last week’s employment report showed some improvement, as evidenced by a slight drop in payrolls and a healthy drop in the unemployment rate, jobless claims rose for the week ending January 30, signaling that the labor market could take another step backward before moving forward. And despite the extended and expanded homebuyer tax credit and mortgage rates hovering near historic lows, both new and existing home sales posted large drops in December, while building permits surged.

A bit more detail… The economy grew at the fastest pace in 6 years according to a preliminary government report showing that GDP grew by 5.7 percent in the fourth quarter of last year. The economy has now grown for two consecutive quarters (3Q GDP: 2.2 percent), suggesting economic activity may be stabilizing. The primary contributors to fourth quarter growth were a 39.3 percent surge in private domestic investment and a slight rise in exports. Moreover, the Conference Board’s consumer confidence index has now risen for three consecutive months, suggesting that households are becoming more confident about future economic conditions.

Turning to the housing markets, recent news is centered on the word: retreat. New home sales fell 7.6 percent in December to 342,000, following a 9.3 percent monthly drop in November. The pace of new home sales is now back to the slow pace set in March of last year. The months’ supply for new homes is back up to an excessive 8.1 months. After rising to the highest level since February 2007, existing home sales tumbled 16.7 percent in December to 5.45 million units. Existing home sales are 15 percent above the levels posted in December 2008, but this recent retreat is troubling. The months’ supply rose to 7.2 from 6.5 posted in the previous month.

New residential construction activity fell 4 percent in December to 557,000, while housing permits unexpectedly rose 11 percent from the previous month. It appears that builders are preparing for a surge in housing demand, likely hoping that the extended homebuyer tax credit, which became fully operable in December, will do its thing. However, the National Association of Home Builder’s index registered a 15 in December and has been falling since August which seems to be out of line with the permits number. Suffice it to say, builders remain nervous about an uncertain housing market.

In other housing information, mortgage rates continue to hover around 5 percent, registering 4.98 percent in the current week. Home prices continue to show some improvement on a month by month basis; but the magnitude of improvement is diminishing. The Case Shiller 20-city home price index fell 5.3 percent in November from a year ago, while the index rose for a 6^th consecutive month (although the rate of increase is slowing). Progress in home values are not evenly spread across the nation. Notably, San Diego, Denver, San Francisco and Dallas are the only major cities in the Case-Shiller 20 city index to experience year over year gains. However, the house price correction that started almost 3 years ago is almost complete even though prices are likely to drop further during the first half of this year due to an expected rise in foreclosure filings. I expect another 6 to 8 percent drop in the Case Shiller index before it is all said and done.

While I’m handing out projections, here are some more: Due to the triple boost caused by falling home values, historic low mortgage rates and the homebuyer tax credit, I expect home sales and housing starts to rise throughout the next several months-perhaps even to May or June. However, once the tax credit expires in April, all bets are off for the second half of the year.

I expect favorable affordability conditions (created by low rates, falling home values, and the tax credit) to stimulate housing activity in the first half of this year. In the second half- rising foreclosure filings are expected to be a drag on housing activity, while job creation is expected to support housing demand. On net, it’s anybody’s game.