It ain’t over 'til the housing market sings
Corporate profits have been great. Through the downturn, a lot of excess fat was cut, and companies have come back leaner and meaner than ever before. In fact, operating margins are back to pushing up against all time highs. But when the Fed turns off the spigot, is all this sustainable? The definition of capitalism alone would tell you operating margins are mean reverting, with or without the Fed’s help. And even without the logic of competition gnawing at fat margins, we are of the mindset that these troubling times aren’t over until housing gets on solid footing and unemployment begins to recover (see Unemployment the LEADING indicator).
True, jobs appear to have recovered somewhat, but we believe the statistics are deceptive. What we are seeing is natural turnover in the labor market with layoffs slowing. In other words, there is the appearance of new jobs on the net, but in reality the rate of new hires is still flat and no actual new jobs are being created. Furthermore, if someone hasn’t looked for a job in 4 weeks, they are considered a “discouraged worker” and the “participation rate,” a statistic used in calculating unemployment figures, drops which leads to an improvement in the unemployment rate despite no new job creation.
The fact is, the economy is still home sick, even with record low mortgage rates. From today’s WSJ: “Unless sales pick up materially this year, 2011 will mark a sixth year in a row of new-home-sales declines and the fewest sales since records began being kept in 1963. One statistic tells the story: The 323,000 new homes sold in 2010 was less than 60% of the number of new homes sold in 1963, even though the population today is nearly two-thirds bigger…We are stuck today, as in the 1930s, in a household recession triggered by excessive debts levels. These, unfortunately, can take many years – not months – to fix.” (“The Housing Headache Felt All Over” by Kelly Evans)
According to a research firm named Clear Capital, housing prices have officially double dipped, dropping below their previous record lows of March 2009. Trouble is, prices will be under continuous pressure since housing inventories are still excessive (not to mention the hidden inventory that isn’t on the market, but secretly waiting to be unloaded as they wait for better days). Gary Shilling, a true expert on the housing market, projects it will take 4 to 5 years to absorb all the excess inventory. In fact, after adjusting for general inflation and the price inflation caused by homes becoming progressively larger, he projects housing prices need to decline another 20% to be in line with history, and that doesn’t include the tendency of markets to overshoot to the downside!
Why is housing so tied to the rest of the economy? Consider a business. Debt holders stand in line first, and any residual income goes to the equity holders. The same goes with housing. Mortgage payments are on average the largest portion of a consumers monthly expenses. Those must be made first, and any residual income can be spent on the rest of the economy – and the consumer makes up over two-thirds of GDP. Thus, we agree with Shilling’s comment, “…another big decline in house prices almost guarantees another recession.” (May 2011 edition of A. Gary Shilling’s INSIGHT)
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