The Fed Delivers a Sobering View on the Housing Outlook and the Dow Hits 14,000!
Stock investors hit the "Buy, Buy, Buy!" button all throughout Bernanke’s Humphrey Hawkins testimony, in a fashion that would make Jim Cramer proud; this despite a more sobering view on the most likely path of the U.S. economy from the Fed. The Fed lowered its central tendency forecast for real GDP by a half a percentage point on the high end for 2007 and by a quarter percentage point for 2008. Is the equity market in denial and bound to correct? It certainly appears that way at the time of this writing, or is the equity market finally looking past the housing malaise? Not only did the Fed lower its outlook for the economy for 2007 and 2008, Bernanke sounded less sanguine about the state of the housing market and the potential spillovers into consumer spending than he did as recently as May.
The June increase in mortgage rates and the move to tighten mortgage lending standards and end abuse lending practices, is bound to hold back housing demand for a time, delaying the much anticipated bottoming of the housing market. June brought a decidedly weaker view of the housing market than we have seen in some time. The National Association of Realtors pending home sales declined 3.5 percent in May. This is highly correlated with actual existing home sales activity one to two months ahead. The commerce department reported that residential building permits dropped 7.5%, to 1.406 million units in June, suggesting another move down in housing starts in the months ahead. The NAHB/Wells Fargo housing market index fell to a 16 year low of 24 in July, and builders reported less buyer traffic and anticipate somewhat weaker sales ahead. Mortgage delinquencies and foreclosures are still rising rapidly in most parts of the country, adding to the nation’s already-bloated housing inventories. Existing home inventories had moderated in the 4Q of last year, but over the last five months have been trending steadily higher once again. The housing market is still mired in a world of hurt, and if Jim Cramer were writing this, he’d be hitting the "House of Pain!" button.
It’s hard to overlook the fact that housing market is embarking on another leg down. It’s like the roller coaster at your favorite amusement park. The first drop is a doozy and you’re not sure if there’s even a bottom. This is where the housing market was in the second half of last year, when residential building was contracting at a 20 percent annualized clip every quarter. Then the coaster reaches a temporary bottom and even begins to rise a bit again, and everyone breathes a sigh of relief. This is where the housing market was in the November 2006 to March 2007 period, only to be flung lower once again. The second drop tends to be a complete surprise, but is not nearly as scary and large as the initial drop. This is what is happening today. Acknowledging the recent spat of disappointing reports surrounding the housing market, we have modestly lowered our forecast for housing starts over the next two quarters. We now expect housing starts to bottom in the first quarter of 2008, instead of the second quarter of 2007. This is likely to trim a tenth or two off of consumer spending and GDP growth all else being equal. It also raises once again the question of whether the U.S. consumer can hold down their lunch as the housing market roller coaster carries on its merry way. We still think they can, and that is the silver lining here.
Unless the housing market downturn leads to a material increase in the unemployment rate, the impact on spending will remain rather limited. This isn’t to say there will be no impact. Already in parts of California, like in San Diego, where housing prices trebled and reliance on ARM’s hit 70 percent of total originations for a time, we are already seeing measurable job losses in construction that has single-handily brought the local economy to a standstill, and may now be holding back consumer spending and retail employment. Other parts of the country are likely to see a similar pattern develop to varying degrees in the months ahead. Yet on average, the U.S. economy will muddle through this adjustment period. The national unemployment rate is expected to only rise by two-tenths of a percentage point over the next year and a half, and real income growth already at high levels for this expansion could improve further if inflation finally moderates. Perhaps this is what the equity market is cheering about. No matter what regulatory hurdles are erected on mortgage lending, or how many hedge funds heavily leveraged on MBS go belly up, the macroeconomic impacts on the economy are likely to be smaller than they were last year and will diminish further over time. Every month the housing market weakness continues, brings us one month closer to the end of the adjustment. I’m still a strong buyer of equities and the U.S. economy at these levels.
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