The negative news in the housing market is beginning to pile up even faster than I suspected. After calling the housing bubble in 2006, followed by government induced stability in 2009 I said the housing market would begin its next leg down once the government stepped aside in April and removed the home buyers tax credit. Since then, fundamentals in the housing market have deteriorated rapidly.
In addition to the very weak mortgage application data in recent weeks, we are seeing some very disturbing data across the board in real estate. Lumber prices are absolutely tanking – now down an astounding 40% from their peak just 6 weeks ago:
Case Shiller data is turning negative again, housing starts are declining and the latest NAHB data was substantially weaker than expected. Bondsquawk elaborates on the weakness in the NAHB data:
“While all attention was made on the gain in the Euro and equity markets yesterday, the National Association of Home Builders released its monthly market index. The NAHB Index data release disappointed by posting a reading of 17 versus market surveys of 21. From the prior month, the index declined 5 points or 22.7 percent from a reading of 22. As points of reference, the index reached a high of 72 in mid 2005 during the housing boom and sunk to a low of 8 in January 2009.
David Rosenberg, economist of Gluskin Sheff looked behind the numbers to paint a more gloomy picture.”
There is no denying the renewed decline in the U.S. residential market, and this transcends the end of the tax credits — the sector is fundamentally weak. Moreover, demand has not reacted to the latest downdraft in mortgage rates and homebuying intentions are, in a word, moribund. The National Association of Home Builders (NAHB) housing market index sagged from 22 in May to 17 in June — a three-month low. Buyer traffic receded from 14 to 16 but the real story was the four point collapse in the “future sales outlook,” to 23 from 27 — it hasn’t been this low since the depths of the recession back in March 2009.
We ran some regressions and found that the “future” component does indeed have the best “fit” with both housing starts and new home sales — the latter is set for a renewed 10% in coming months, to a 600k annual unit rate, and the latter by 30% to the 350k level, which would very close to the all-time low of 338k hit in February 2010. Ouch!
Adding insult to injury are recent comments out of Toll Brothers who is seeing very weak trends in their markets just a few months after calling for a robust recovery in housing (not surprisingly, Robert Toll has not been an active buyer of his own shares despite dumping massive quantities on the market at just about every short-term peak). Joel H. Rassman, chief financial officer of Toll elaborates:
“In the three weeks following our earnings conference call on May 26, 2010, our per-community deposits have been running about 20% behind the comparable period in last year’s third quarter and our per-community traffic has been running about 3% behind. Thus, for the first six weeks of our FY 2010 third quarter beginning May 1, 2010, we are slightly ahead of last year’s third-quarter pace of contracts signed on a per community basis. However, we have 21% fewer communities than one year ago.
“Typically, the strongest selling season for new homes begins at the end of January and ends in late April. Our third fiscal quarter, which encompasses the period from May 1 through July 31, is typically slower. For the 20 years between 1990 and 2009, we signed contracts for approximately 8.23 homes per community on average in our second quarter compared to 6.21 homes per community on average in our third quarter. We signed 4.32 contracts per community in FY 2010’s second quarter. Although better than FY 2009’s second quarter, this was approximately half our historical average. Because we typically sign fewer contracts per community in our third fiscal quarter than in our second fiscal quarter, we currently anticipate that our total net signed contracts in FY 2010’s third quarter will be less than those signed in our FY 2010 second quarter.
“Although demand in recent weeks has been quite choppy, in general, we continue to believe that the housing market has emerged from its darkest period of late 2008 through early 2009. Interest rates remain near historic lows, affordability is near historic highs and there are positive signs of growth in the economy. We believe pent-up demand exists. At the moment, consumers view the economic glass as half empty: volatile financial markets, global deficit concerns and the oil spill in the Gulf are all contributing to this gloom. We believe that once the employment picture begins to brighten and the economy stabilizes, consumer confidence will improve and the housing market should begin a steadier recovery.”
Well, with government austerity on the table, Census lay-offs on the way, the end of government stimulus and a still very cautious private sector (thank you European debt crisis!) it’s unlikely that employment is jumping to the necessary 250K+ level any time soon. Therefore, what Toll is essentially telling us is that they’ve just experienced their strongest portion of the year (which wasn’t that great) and things are starting to deteriorate rapidly. Not good signs.
This looks like classic deflation mentality to me. The similarities with Japan are becoming more and more frightening by the day. Remember, real estate was the epicenter of the entire credit crisis yet the market appears so fixated on Europe that it’s missing this enormously important domestic story. The deterioration in consumer balance sheets via real estate set-off the longest recession in the last 75 years. Although Ben & Co. believe this is a bank driven crisis (something which I believe he has now been proven entirely wrong about) this was actually a consumer driven balance sheet recession. The deterioration of the consumer’s largest asset is a very bad sign of things to come.
This is a central bank’s worst nightmare. You can’t solve a problem that is largely driven by psyche by applying traditional monetary policy. And don’t be fooled – deflation is as much a psychological event as it is a monetary event. To anyone who has done their homework in housing it’s clear that home prices are still bloated on a national level (as much as 30% according to historical levels), supply remains high, and that means there is no great rush to buy. This is the classic deflationary trap – “why buy now if prices might drop?” Anyone who has lived in Japan in the last 20 years is well aware of this psychological phenomenon. And just like Japan, every time fiscal stimulus stopped the economy retrenched as fiscal austerity exposed a fundamentally weak and psychologically fragile private sector. Now that the government incentive is out of the way and we’ve stopped what was essentially a price fixing scheme at the government level, the market is showing its true colors and they are not pretty.
Move over Europe. We have bigger problems to deal with here at home over the next 18 months….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.