Housing Recovery Still Far Off

Heading into the new year, the consensus seems to be that housing is bottoming. The people who hold this view point to the November housing data:

  • Existing home sales rose in November following October’s increase. Down 10.7% year-over-year.
  • Total housing inventory fell by 1%. Up 30% yoy.
  • New Home Sales rose by 3.4%. Down 15.3% yoy.
  • Housing starts increased 6.7%. Down 25.5% yoy.

And as expected the stocks of home builders have been rallying:


What could have caused this increase in housing activity? Three things come to my mind: 1) a reduction in prices or greater incentives offered by sellers who are unable to make their mortgage payments and are desperate to sell their homes, 2) falling mortgage rates causing mortgage applications to rise according to the MBA survey, and 3) an increase in real wages.

Whatever the reason it’s important to put this data in the proper context. Over the past year home sales still are in a downtrend and inventories are near recent highs. And as any chartist knows, no data or price action will trend upwards or downwards in a straightline — pullbacks are to be expected. Looking at the following graphs by the Wall Street Journal, I find it hard to conclude the housing is out of the woods just yet.


I have been a housing bear for a long time and the fundamentals still have not improved. Here are some reasons why I think housing activity will slow even further:

  1. The number of building permits issued, a good forecaster of future housing activity, fell by 3% in November as compared to October.
  2. The rate of home buying cancellations which has exploded is not factored into the home sales and inventory data which will lead to major downward revisions later on.
  3. According to past housing cycles, the peak-to-trough decline in housing starts is 47.3%. In the current cycle housing starts have so far only declined by 24.4% from February 2005’s peak.
  4. Households are spending a record percentage of their incomes on mortgage obligations.
  5. The recent rise in foreclosures will lead to a tightening of lending standards.
  6. Mortgage rates will increase due to foreigners reducing their US debt purchases.

For these reasons I believe housing is going to continue being a drag on the economy in 2007. How much of a drag? To answer this I like to refer to an excellent chart by Calculated Risk. According to Calculated Risk:

This graph shows starts, completions and residential construction employment. (starts are shifted 6 months into the future). Completions and residential construction employment are highly correlated, and Completions lag Starts by about 6 months.

Based on historical correlations, it is reasonable to expect Completions and residential construction employment to follow Starts “off the cliff”. This would indicate the loss of 400K to 600K residential construction employment jobs over the next 6 months.

In addition to the residential construction layoffs, there will be significant job losses among real estate agents and mortgage brokers. Approximately half of all private sector jobs created since the 2001 were tied to housing. The loss of most of these jobs should easily be enough to tip the economy into a recession.

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