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There was some more bright news out of the housing market this morning. New home sales rose more than expected to 337,000.   Unfortunately, the demand/supply mechanics of the housing market are improving little:

The months’ supply of homes on the market fell slightly to 12.2 months in February from 12.9 months in January. This is still well above the 9.7 month supply in February 2008.

It’s not surprising that home sales are increasing early in the year.  After all, housing is a very seasonal industry.  This is one of the primary reasons why I believe we will experience a “false dawn” in home prices in the first half of 2009.   While it’s great to see an improvement in demand investors must not overlook the other important indicators: affordability and supply.   As more and more Americans lose their jobs and credit lines it is unlikely that we will see a sharp increase in home prices any time in the next two years.  The deflationary forces at work are simply too large to overcome in such a short period of time.

I prefer to think of the credit crisis like a snake digesting a large animal.  As humans we need instant gratification.  We view everything in the short-term.  But economies are so large and so slow moving that our animal instincts simply do not mesh well with economic behavior.  It is one of the main reasons why most people are poor investors – they are simply unable to control their emotions through the short-term swings in the market.

Unfortunately, we are on the downside of the business cycle and it is wreaking havoc on the investor psyche.   Instead of viewing this whole episode as if you’re eating in the parking lot at McDonalds try to think of this economic process as if you’re a snake consuming a deer.  This is 25 years worth of debt that is all coming to fruition at once.  After taking down prey (debt) that we never should have attacked in the first place we are now left with the unholy task of digesting (de-levering) it.  It will not be swift, it will not be pretty, but the ultimate result will be satisfying.  Unfortunately, it will take longer than 2 years for the global economy to swallow two decades worth of debt and that means lower home prices are an inevitability.

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