The
Long Road Home
This
week brings a mix of policy and data, but the Supreme Court's consideration of
the Affordable Care Act will likely draw most of the media's attention. This
week's U.S. economic data is a mix of data on: 1) manufacturing in February
(durable goods orders) and March (Richmond, Kansas City and Dallas Fed
manufacturing indices along with the Chicago area Purchasing Managers
Index-PMI); 2) housing (pending home sales in February); 3) and consumer
sentiment for March. Markets will be looking for signs of slowdown in the
United States after seeing the weaker data in Europe, the U.K. and China last
week. The release of the German IFO index for March and the March PMI in China
are the data highlights overseas. The real action, however, may be on the
policy front this week, at home and abroad.
The
U.S. Supreme Court will hear arguments this week on the Affordable Care Act.
The hearings will get a lot of media attention, though a decision by the
Supreme Court is not due until the end of June. While the Federal Reserve’s
(Fed) next Federal Open Market Committee (FOMC) meeting is still five weeks
away, the debate over whether or not the Fed will conduct another round of
quantitative easing (QE3) will be in the news this week, as no fewer than 10
Fed officials make public appearances. There are more policy hawks (those
favoring the low inflation side of the Fed’s dual mandate) than doves (those
who favor the full employment side) on the docket, and so by the end of the
week, the market may doubt that QE3 is still on the table. Our view remains
that unless the economy accelerates noticeably in the next several months, the
Fed is more likely than not to do another round of quantitative easing in the
second half of the year. In addition to the Fed speakers, there are several key
finance ministers’ meetings (and debt auctions) in Europe this week, and
leaders of the BRIC nations (Brazil, Russia, India, China) will meet in India
amid slowing growth in many emerging market economies.
Still on the Road to Recovery
Housing
was in the news last week, and there are several housing-related reports due
out this week as well. As we have noted in recent commentaries, the U.S.
housing market is still in the process of recovering from the 2006 – 09 bust that
followed the housing boom that began to show severe cracks in 2007 and
collapsed in 2008. The collapse in housing, in turn, was a major contributor to
the financial crisis and Great Recession of 2007 – 09. The housing market,
along with many financial markets, and many economies around the globe are
still feeling the after-effects of the housing collapse.
As
the old saying goes, the real estate market is all about “location, location,
location.” When we discuss the housing market, we do so from a national
perspective: what is happening to the housing market on your street or in your
neighborhood, town, city or state may be completely different (better or worse)
than what is happening nationwide.
With
that important caveat in mind, we can say that the housing market (sales,
prices, construction, etc.) hit bottom in early 2009 and has been moving
sideways to slightly higher since then. Housing construction (which is the most
direct way housing impacts gross domestic product–GDP) has not been a
significant, sustained contributor to economic growth (as measured by GDP)
since 2005. The lack of participation from housing has been one of the main
reasons (along with the severe cutbacks in state and local governments) behind
the so far sluggish economic recovery. Looking ahead to the remainder of 2012,
we see only a modest contribution to GDP growth from housing, as the positives
slightly outweigh the negatives.
There
are a number of direct (housing starts, housing sales, construction spending,
home prices) and indirect (homebuilder sentiment, mortgage applications,
foreclosures, inventories of unsold homes, mortgage rates, housing vacancies,
lumber prices, prices of publicly traded homebuilders) ways to measure the
health of the housing market. These data are collected and disseminated by both
the U.S. government and by private sources. A quick recap of these various
indicators is below.
Taking the Pulse
· Near-record
housing affordability.
Housing affordability, the ability of a household with the median income to
afford the payments on a median priced house at prevailing mortgage rates, is
at an all-time high. Rising incomes, record-low mortgage rates, and the
aftermath of the 20 – 30% drop in home prices nationwide account for the record
level of affordability.
· Homebuilder
sentiment.
At 28 (on a scale of 0 to 100, where zero is the worst and 100 is the best) the
index of homebuilder sentiment has surged over the past nine months and now
sits at a four-and-a-half-year high albeit still at a very low level. The homebuilder
sentiment data is compiled by the private sector’s National Association of Home
Builders.
· Inventories of
unsold homes are low.
Despite a “shadow inventory”, homes in or close to foreclosures and homes still
sitting on bank balance sheets, inventories of unsold existing homes are the
lowest they have been since 2006 – 07. The official count of the inventory of
unsold single family existing homes (from the National Association of Realtors)
tells us that 2.1 million existing homes are for sale. Depending on the data
source (there is no “official” number for shadow inventory) cited, the shadow
inventory is in the range of 1.5 – 2.0 million. While still well above average,
the shadow inventory has come down over the past few years as well. It may rise
later this year as foreclosures ramp up again after the moratorium was lifted
earlier this year.
· Housing starts
and building permits.
Responding to less demand for housing, difficult credit conditions and a glut
of unsold inventory, homebuilders drastically cut the number of new housing
starts in recent years. Housing starts peaked at 2.4 million units in early
2006 and by early 2009 had dropped to under 500,000 units, an 80% drop. Since
then, as inventories of unsold new and existing homes shrunk and the economy
and financing conditions improved, starts have moved 50% higher. Despite the
50% move off the bottom, housing starts remain 70% below their all-time high.
Both housing starts and building permits (a key leading indicator of starts)
are collected by the U.S. Commerce Department.
· Homebuilder
stocks.
Although they are not a perfect leading indicator of the health of the housing
market, the S&P 500 Homebuilders Index has rallied by nearly 80% since
October 2011. Despite that dramatic rally, homebuilding stocks are still 75%
below the peak hit in mid-2005.
· Lumber prices. Lumber is a
key input to the homebuilding process. Lumber prices peaked in mid-2004 — a
year or so before the housing market peaked — and declined by nearly 70% by
early 2009. Since early 2009, lumber prices have increased (in fits and starts)
by 75%, but remain more than 40% below their 2004 peak. Lumber prices are set
in the open market, trading on several global commodity exchanges.
· Supply and
demand for housing credit, bank lending to consumers for mortgages. From the
mid-1990s through late 2006, bank lending standards (down payment required,
credit scores, work history, etc.) for residential mortgages were relatively
easy. Coupled with low rates and rapid innovation in financial products backing
residential mortgages, this easy credit helped to fuel the housing boom. The
banking industry began tightening lending standards in early 2007, and
continued to tighten for more than two years. Lending standards eased in 2009
and 2010, and have only recently returned to where they were in 2003. On the
demand side of the equation, consumer demand for mortgages remains muted, as
consumers are uncertain about prospects for home price appreciation and their
own financial and labor market status in the years ahead. This data is compiled
by the Federal Reserve in the Senior Loan Officer Survey, which is released
quarterly.
· Mortgage
applications.
Measured by the private sector’s Mortgage Bankers Association, the volume of
mortgage applications has increased fourfold since late 2008, but remains well
below its mid-2000s peak. Weekly mortgage applications are a key gauge of
consumer demand for housing, and as we enter the key spring selling season —
40% of home sales occur between April and July — weekly mortgage applications
will be a key metric to watch. Mortgage applications are a component of our
weekly Current Conditions Index.
· Foreclosure
activity.
After a de facto moratorium on new foreclosures was put into place in late 2010
as the United States and individual state governments sued mortgage processors
and banks, the pace of new foreclosures slowed down. By early 2012, new
foreclosures were at the lowest level since mid-2007. Now that the legal action
has been settled, there is a concern
that the foreclosure pipeline will fill back up again. While we may see some
spike higher in foreclosures and sales of foreclosed-on bank-owned properties
in the coming months, it is important to note that the pipeline of new defaults
and overall mortgage delinquencies are falling, aided by a better economy and
job market. There are various public and private sources for foreclosure and
delinquency data. On the private sector side, firms like RealtyTrak, Lender
Processing Services and the Mortgage Bankers Association provide data. Freddie
Mac, Fannie Mae, and the Federal Housing Finance Administration (FHFA) are
among the government agencies that compile data on delinquencies and
foreclosures.
· Construction
employment.
As measured by the U.S. Department of Labor, construction employment increased
by more than one million between the early 2000s and 2006 to nearly 3.5 million
workers. Since then, workers employed in the construction of new homes has
dropped by nearly 50%, bottoming out at just under 2 million in late 2010.
Since then, construction employment has held steady, but has yet to make a
decisive turn higher.
· Construction
already put into place. The value of new residential construction put into
place peaked at $535 billion in early 2006. Since then, construction of new
homes has plummeted, and by mid-2009, just $122 billion in new home
construction was underway. This data series moved sideways for about 18 months,
hitting another low ($120 billion) in late 2010. Since then, there has been a modest
uptick in construction of new homes, but new home construction is still running
75% below its peak. This data is collected by the U.S. Commerce Department.
· Home prices. There are a
variety of sources for home prices from both the private sector — Case Shiller
Home Price Index, CoreLogic, Zillow, RadarLogic, National Association of
Realtors — and the U.S. Government — Freddie Mac, Fannie Mae, Federal Housing
Finance Agency, etc. In general, these indices all suggest that home prices
fell by between 20% and 30% between mid-2005 and early 2009, and are at best
unchanged since then. Price changes before, during and after the bubble vary
widely by region, price of home and type of property (single family versus
condo, distressed and non-distressed, etc.).
· Demand for
housing.
New household formation is running just under 1% per year. Contrast that
against the 80% drop in new housing starts over the past five years. The gap
between new household formation and new housing starts had never been wider,
leading some analysts to suggest that we are quickly running out of houses.
But, with so many vacant homes (18 million or so), and young people (and older
relatives) living with other relatives, it is difficult to say just how quickly
we will run out of housing. The U.S. Census Bureau collects the data on
household formation and the housing vacancy data.
On
balance, the housing market continues to struggle three years after hitting
rock bottom, and in some cases seven years after it peaked. How quickly housing
can recover from here will help to determine the pace of the overall economic
recovery. Warmer and drier than usual weather this winter may help to explain
some of the better housing data of late. Warmer weather generally means better
housing data (sales, construction, showroom traffic, etc.), so it may be that
the better tone to the housing market is purely a function of the weather. We
need to see some more normal weather and get past the traditional spring
selling season to be sure. Our best bet is that the slow recovery in housing
will pick up some steam in 2012, but that it will still take several more years
before the national housing market is back to normal.
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IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are
not intended to provide specific advice or recommendations for any individual.
To determine which investment(s) may be appropriate for you, consult your
financial advisor prior to investing. All performance reference is historical
and is no guarantee of future results. All indices are unmanaged and cannot be
invested into directly.
The economic
forecasts set forth in the presentation may not develop as predicted and there
can be no guarantee that strategies promoted will be successful.
Stock investing
involves risk including loss of principal.
International
investing involves special risks, such as currency fluctuation and political
instability, and may not be suitable for all investors.
Quantitative Easing
is a government monetary policy occasionally used to increase the money supply
by buying government securities or other securities from the market.
Quantitative easing increases the money supply by flooding financial
institutions with capital in an effort to promote increased lending and
liquidity.
The Federal Open
Market Committee action known as Operation Twist began in 1961. The intent was
to flatten the yield curve in order to promote capital inflows and strengthen
the dollar. The Fed utilized open market operations to shorten the maturity of
public debt in the open market. The action has subsequently been reexamined in
isolation and found to have been more effective than originally thought. As a
result of this reappraisal, similar action has been suggested as an alternative
to quantitative easing by central banks.
The Federal Open
Market Committee (FOMC), a committee within the Federal Reserve System, is
charged under the United States law with overseeing the nation’s open market
operations (i.e., the Fed’s buying and selling of United States Treasure
securities).
The Chicago Area
Purchasing Manager Index that is read on a monthly basis to gauge how
manufacturing activity is performing. This index is a true snapshot of how
manufacturing and corresponding businesses are performing for a given month. A
reading of 50 or above is considered a positive reading. Anything below 50 is
considered to indicate a decline in activity. Readings of the index have the
ability to shift the day's trading session one way or another based on the
results.
This research
material has been prepared by LPL Financial.
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