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There are more than subtle signs that the housing markets may be recovering and the worst may be over. Recent data releases support this notion.

Housing Recovery May Be in Sight

There are more than subtle signs that the housing markets may be recovering and the worst may be over. Recent data releases support this notion. Housing reports suggest that home sales and residential construction activity may be scraping bottom. The three major housing measures- existing home sales, new home sales and housing starts-are hovering above their cyclical lows posted in January of this year. Home values are currently falling but at a slower pace than the pace registered in January. Is the worst really behind us or has recent housing data given us a false hope?

There are some positive developments that support the notion that the housing cycle’s nadir is in our rear view mirror. Mortgage rates continue to hover near historic lows providing low cost financing for those who can get it. Mortgage credit remains tight but a bit looser than a few months ago; enough to spur refinancing activity. Pending home sales (as measured by an index) jumped 3.2 percent in March, portending favorably for future existing home sales.

The support system for the housing sector- the U.S. economy- may be also be improving. Recent economic releases indicate that the economy is contracting at a slower pace in the second quarter than in the previous two quarters. GDP fell by 6.3 percent in the fourth quarter of last year and 6.1 percent in the first quarter of this year. We expect GDP to contract by 2 to 3 percent in the second quarter.

Positive economic news has been hard to come by in recent months but some economic indicators are improving. On the consumer side of the economy, chain store sales were up 0.7 percent in April, the first increase since September 2008. Perhaps more importantly, the University of Michigan’s consumer sentiment survey for April was up 7.8 points and has increased for 2 consecutive months. The improvement in sentiment was led by an increase in expectations. A meaningful increase in consumer confidence suggests that the economy might be poised for recovery. On the business side of the economy, the ISM manufacturing index was up to 40.1 in April compared to 36.3 in March. This index has increased for four consecutive months, a welcomed development. The employment situation may also be improving. Weekly jobless claims for unemployment insurance have trended downward to 601,000 for the week ending May 2 from a cyclical high of 674,000 for the week of March 28.

These positive developments were bolstered by remarks made by Federal Reserve Chairman, Ben Bernanke when he testified before Congress this past week. He stated that he expects economic activity to bottom out, then to turn up later this year. He also noted that the housing market is beginning to stabilize.

Improvements in the financial markets are also in line with our expectation for the downturn to wind down towards the end of the year. Long term yields are now higher than short term yields; credit spreads have narrowed and the stock market has advanced these past several months.

Government intervention directed at stimulating the economy and improving the financial markets has been effective. The $787 stimulus program (via tax breaks and public spending) has helped slow the pace of economic contraction. The Federal Reserve’s efforts to keep interest rates near historic lows has kept borrowing costs down and new foreclosure mitigation programs are beginning to show promise in limiting the number of foreclosure filings.

At first glance, the worst may be over for both the housing markets and the economy. But before we book a flight to Disney World, let’s dig a bit deeper; there still remain problems.

According to estimates, over 20 percent of homeowners are underwater (i.e., their loan balances exceed the value of their homes) and home values continue to fall so that percentage may get worse. There also remains an oversupply of homes in the housing sector, exerting downward pressure on home values. Foreclosures also continue to mount, depressing home values further.

In addition, the Treasury Department’s stress tests for banks receiving government assistance indicate that a number of large financial institutions need to raise more capital to meet government requirements as well as survive the economic downturn. Bank of America recently announced that it needs $34 billion in additional capital. And although weekly jobless claims have dropped, the economy shed a whopping 539,000 jobs in March while the unemployment rate climbed to 8.9 percent. The pace of contraction for the economy may be slowing, but the economy is still contracting, creating a poor backdrop for housing activity.

Again, the worst may be behind us for the economy and housing markets. There are two reliable leading indicators that suggest this is true-the stock market and housing starts. Most equity market indices have advanced these past several months. Stock market rallies usually lead economic recoveries as investors anticipate better economic times ahead. Similarly, single family housing starts have stabilized and homebuilder stocks have inched upward. In past recessions, a recovering homebuilding industry precedes a housing and economic recovery.

Whether the housing recovery occurs late this year or early next year, it is likely that the rebound will be modest. The housing sector has endured too much pain over the past several years to recover in a relatively short period of time. We expect an unexceptional recovery at best.

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