One of the factors supporting the Model “T” forecast of a “UL” shaped recovery is a continued weak housing market recovery (See “What the Model “T” says about the Economic Recovery). Residential construction is very important to the model because it is based on commercial transportation factors and housing has a big impact on freight. Trucks are involved at all stages of the process. They are used to move dirt and raw materials, then construction materials and finally for consumer products to furnish and enhance the completed dwelling. During the housing boom, certain factors in the model rose in tandem with housing starts; of course they fell just as hard after the bust. Housing is not a leading indicator for freight. They tend to move together and how closely is dependent on housing’s overall influence on the total economy at the time.
Housing is also an important factor in economic recoveries. It has led the recovery in the previous seven recessions going back to 1960 (David Berson, PMI Group). Consumer spending has historically been the other key recovery factor.
If the housing market is so important to recovery, it is vital to determine the “basic economics” of the sector as we approach 2010.
Factors Impacting Demand
Demand for houses is being propped up by the first-time homebuyer tax credit, government backed FHA loans and very low interest rates. This has recently increased sales of existing homes, but this demand is not normal. A very high percentage (90%, Inside Mortgage Finance) of these sales are foreclosures, short sales (lenders agree to the sale of a home for less than the balance of their mortgage) and distressed sales (due to job loss).
September new home sales were at an annual rate of 402,000. While this is 22% above the January low (the low base number inflates the percentage increase!), it is 8% below a year ago and a whopping 48% below 2007 actual. New home sales, especially at the high end, are restricted by tight credit, weak consumer confidence and wage reductions. Future demand is limited by a declining number of first-time buyers, reduced FHA loans and possible higher interest rates.
Factors Impacting Supply
September housing starts were only 590,000 (seasonally adjusted annual rate). The numbers had been improving after bottoming out, but have now flattened. There is still 7.5 months of inventory, but this is better than earlier this year. Existing home inventory is 3.6 million and growing. There were 937,840 foreclosures in Q3.
The number of foreclosures is expected to rise due to:
- There are a large number of houses that are in the process of foreclosure or delinquent on payments
- Many adjustable rate mortgages will rest at higher rates in 2010 and 2011
- The number of voluntary foreclosures (otherwise known as strategic defaults, being underwater, etc.) caused by people with mortgages larger than the value of their homes is growing. There were 588,000 (1 out of every 5) of these defaults last year. Moody estimates that currently one third of all mortgages are underwater.
- More foreclosures are occurring on expensive homes and prime loans as higher income people lose their jobs and are unemployed for an extended time.
Amherst Securities Group forecasts that 7 million properties may be foreclosed upon and be dumped into the market. It would take 1.3 years to sell this inventory at current sales levels. Adding to possible supply increases is the “shadow inventory” (because it lurks behind the numbers and can’t be counted). This inventory consists of banks that are holding foreclosed and distressed properties off the market now, with plans to put them up for sale when the market (and prices) improve. It also includes home owners who need to sell, but are waiting for the same thing.
Impact on Prices
Housing prices are down 32% from peak (Case- Schiller, although this varies widely by market). Due to the strong expected increase in supply and the forecasted tepid increase in demand, Fiserv is forecasting prices to fall another 11%, bottoming in the summer of 2010. Moody’s says Q3, 2010. If the supply of foreclosed homes pours out on the market too quickly, prices could drop another 25%, back to 1998 “pre-bubble” levels.
The WSJ Economic Panel is forecasting (averaged) housing starts at 840,000 a 260,000 increase over 2009. This seems optimistic considering September building permits were only at a rate of 573,000 and the National Association of Home Builders (NABH) Builder Confidence Index is at a very low value of 18. The NAHB 2010 forecast of 716,000 housing starts looks more realistic, but still could be high.
What it Means
The economy will have problems growing above trend next year (3%) with the housing market this weak. The commercial transportation market can expect another poor year (although better than 2009) in 2010. Which means the Model “T” predicts a sluggish stock market for most of next year.
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