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The
Outlook for the Housing Market
by John Mauldin
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The
Outlook for the Housing Market
The True Wealth Effect
When
Will the Fed Raise Rates?
The Consensus is Wrong
Early To
Rise
This is
always a fairly intensive research time of the year for me, as I
begin to format my thoughts about the possible trends for the coming
year. Next week, I will sit down on Thursday and Friday to write my
annual forecast edition. It will be a shorter letter this week, as I
husband my energy for next week's marathon.
But today we
will preview one part of the puzzle that will be 2004: the housing
market and its implication for interest rates.
One of the
secrets of the arcane art (it is not a science!) of economic
forecasting that I practice is to look at the consensus forecasts
and to try and discern the reasons for the consensus. Given that
most consensus thought is based upon projecting current trends or
wishes into the future, the key is to discern what events might
transpire which could upset current trends and thus make the
consensus thinking likely to be wrong.
Last week Barron's
polled the usual list of famous analysts, and asked them what they
thought was in store for interest rates. The average suggested an
almost 1% rise in ten year rates, which is the figure that
influences mortgage rates the most. They would suggest that mortgage
rates will rise to 7% or more by the end of the year.
The True Wealth Effect
I have written before of studies which show that consumer
confidence and thus consumer spending is highly correlated with
housing prices. The true "wealth effect" is not in stocks but in
homeowner equity.
Thus, as home values continued to rise
throughout the recent bear markets and recession, consumers were not
as worried as in past recessions, and therefore barely skipped a
debt-financed consumer spending binge. The Fed helped foster this
mood by creating the climate for ever lower mortgage rates. Let us
make no mistake - housing prices are linked to two key factors:
demand and interest rates. Demand, it seems, is also spurred on by
lower mortgage rates.
Since much of our future economic
well-being is mortgaged to the housing market, it will serve us well
to look at a few facts.
Let's go to the website of the
National Association of Realtors to see what we can glean from
existing home sales. First, we went on a buying binge as a result of
the low rates of this summer. Home sales peaked at a seasonally
adjusted all-time high of 6.69 million homes per year. Looking at
third quarter data, it seems we were buying at a pace of 7.4 million
homes per year. This is up from a pace of 6 million only a few years
ago.
This has dropped in the last two reporting months,
declining over 9% from September's peak and back toward the still
high numbers from 2001. The average "supply" of existing homes for
sale has grown from a 4.3 months to 5 months in just the last two
months. But is the glass half-empty? Even dropping 9%, it was still
6.9% above last year.
Rates are roughly where they were at
the beginning of the year. But the drop in the summer to 5% mortgage
rates clearly spurred a huge increase in buying. The national median
existing-home price was $170,900 in November, up 5.9% from November
2002 when the median price was $161,400. The median is a typical
market price where half of the homes sold for more and half sold for
less. That sounds good for homeowners, but Greg Weldon notes that
housing prices in November declined and this marks the 4th straight
month where prices did not rise and a cumulative decline over that
period was nearly 6%.
Will we now return to more "normal"
levels but still stay relatively high? If we do, then the seemingly
ever present annual increase in housing prices should continue. But
what if the slowing of demand continues? At some point, weak demand
will halt the pace of increasing housing prices. |
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It's All
in the Assumptions
Investors
assumed that stocks would rise forever, and bid up the price of
stocks right up until March of 2000. Once again, investors assume
that stocks will rise again, as we return to the 90's. Such
psychological forces are powerful. That being said, expectations of
increased housing prices are even more ingrained in the national
psyche.
Let's look at the home construction industry and
housing starts. Again, thanks to Weldon for looking at the new home
sales data. He notes that new home prices are rising significantly,
up almost 10% from October to November, as builders are forced to
pass through increased costs. Predictably, sales went down. They
have dropped by 5% over then last two months and unsold supply is
7.4% higher than last year.
(As an aside, in researching
this market, I went back and looked at new home sales for the last
35 years. The latest data I could find suggest new home sales will
be in the 1.8 million range for the year. If you had made me guess,
I would have bet that new home sales are at all-time highs. I would
have been wrong, and not even reasonably close.
New home
sales were 2.35 million in 1972, when the population was 25% less:
210 million compared to today's 280+ million.)
There are 109
million households in the US. Population is growing
by less than 1%. We are building homes at a growth rate over twice
that of the number of increasing households. Unless new first time
buyers can be brought into the market, the home construction
industry will experience a rough patch.
1940: A
Nation of Renters
But not to
worry. With low interest rates, more people can afford to buy homes
and are doing so. Home ownership rates have increased from 64% of
the nation to 68% in the last 9 years. In 1940, the rate was less
than 43.6%. We were a nation of renters at the beginning of this
century. Freddie Mac tells us that will grow to 68.5% by 2010.
President Bush just signed a new bill giving lower income
first time buyers a gift of $5,000 to make their purchase. Freddie
Mac has a wonderful chart showing home ownership rates going onward
and upward. They tout their "new technology" which allows for 3%
down payment programs and lower origination costs as a reason to be
optimistic, as well as an aging population which will want to buy
more homes.
Or maybe we should worry. What if the consensus
in Barron's is right and mortgage rates climb another 1% over the
year? That increases the average payment of a home and thus
decreases the dollar cost of homes that families can afford. It also
shuts out homebuyers at the lower end of the economic scale.
What is the tipping point? What is the point at which higher
rates weaken demand enough to slow (or even drop) the average price
of a home?
Higher rates are not a problem in an economy that
is growing AND producing new jobs. But the
US economy is simply
growing. We are producing some 90,000 jobs a month, but need to be
doing twice that to really lower the unemployment rate. While the
jobs picture is slightly better, much of the improvement in the
statistics comes from the 4,000,000+ people since March of 2001 who
are not counted as unemployed because they are no longer looking for
a job. Some sources suggest that counting them, plus the marginally
employed, would run the rate up to a more European like rate of
close to 9%.
Bill King writes "Consumers' assessment of the
job market deteriorated in December. Those saying jobs are "hard to
get" rose to 32.6% from 29.6%. Those claiming jobs are "plentiful"
declined to 12.5% from 13.5%. Current business condition sentiment
also fell."
This adds one more reason as to why I think the
Fed will not raise rates until at least after the election next
year. Raising rates without an expanding job market will simply put
the kibosh on home values.
When Will
the Fed Raise Rates?
For those who
keep asking me when the Fed will raise rates, I simply respond that
they will not do so until the economy is clearly producing new jobs
at a sustainable pace of 150,000 or more per month for several
months.
Here is the equation: a lower unemployment rate will
result in higher demand for homes. Higher interest rates will
decrease demand for homes. A sufficiently decreased demand for homes
will lower home prices. Lower home prices are the one thing that
consumers will not tolerate. Lower home prices will result in lower
consumer spending. Lower consumer spending will set the stage for a
recession. |
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The
Consensus is Wrong
The Fed
understands this, even if the economists polled in Barron's do not.
Thus, arriving back at the beginning, the Fed will not raise rates
until the unemployment picture improves significantly.
But
John, you old worry wart, aren't we seeing a better jobs market? The
answer is yes, but I said significantly better, not just marginally.
In November, according to the Consumer Confidence Survey of
the Conference Board, 2% of US households expected to buy a home in
the next 6 months. Last week, that number dropped to 1.4%. That does
not equate to a housing market of some 8 million new and used homes
being sold in one year.
That is not as bad as it might
sound, as many of us do not know we are going to change jobs or be
forced to move within the next six months. We are a transient
nation. How many of us have known six months in advance we were
going to change jobs and move? But the one month drop-off is still
disconcerting. Evidently, a lot of potential homebuyers decided to
take advantage of the lower rates and stepped up their time frame.
We have "bought forward."
Further, if only 1.4% are
expecting to buy, that also means there will be fewer sellers. Lower
existing home sales is not bad thing in terms of housing prices, as
long as supply and demand are balanced with fewer people wanting to
sell (unless you are in the real estate business).
Taken all
together, if the recent softening data is telling us anything, it
suggest that it will take an improving unemployment picture simply
to MAINTAIN housing demand, let alone increase it enough to let the
Fed feel comfortable about raising rates.
Next week, we will
examine how much of the recovery can be laid to the stimulus from
tax cuts and mortgage refinancing. But since we are on the subject
of housing, let's look at the mortgage application data. Weldon
notes in last week's Money Monitor:
"Meanwhile, the already
severe, and now worsening, EROSION in the Fixed- Rate sector
continues unabated:
"Fixed-Rate Mortgage Applications ...
down (-) 7.5% for the week, putting it down (-) 25.4% over the last
four weeks, and DOWN by a STEEPLY negative (-) 45.6%
yr-yr.
Even WORSE:
"Refinance Index ... reading of 1908.3 in
latest reporting week, was down (-) 7.9% for the week, but more
importantly, represented the SECOND LOWEST reading of the YEAR,
second only to the lowest reading posted just two weeks ago ...
while the Applications for Refinancing have PLUNGED by (-) 53.5% on
a year-year basis.
"Indeed, the Refi-Index has
now posted two weeks in the last three, BELOW the 2,000 level.
Compare that, with this year's PEAK reading, posted at 9,977.8
during the last week of May, during a string of three consecutive
weeks ABOVE 9,000 !!!"
This is not to say the housing sector
is getting ready to fall off a cliff. It is not. It will slow down
from the torrid pace of 2003, but is should remain ok for 2004, as
the point is that the Fed is going to do everything in its power to
keep rates low, and I think rates are going to stay low a lot longer
than the conventional wisdom thinks. That should help at least
maintain housing prices, if not continue to give them their usual
upward growth.
I will talk more on rates next week, as they
are one of the keys to 2004, but for now, let's end this letter a
little earlier than normal, with a recommendation for starting off
your New Year.
Early To
Rise
I will give you
one of my little secrets: my friend Mark Ford writes the excellent
(and free) daily e-letter, Early to Rise. Spending a few minutes
reading it each day is like having my own personal business coach.
It focuses on business and marketing issues as well as personal goal
setting strategies, etc. ETR is one of my must reads. You can get it
at http://www.earlytorise.com/SuccessStrategies.htm.
Mark is one of the best marketing minds in the world.
San
Francisco,
LA, and
Miami
This next year
looks like it could be one of the best in terms of my personal
business. While 2003 was a good year, it was the most stressful year
of my life. I am glad to see 2004. It also is shaping up to be one
of the busiest travel years of my life, which means a lot of planes,
but also the opportunity to see more of my clients and friends. I
have put off so much in an effort to finish the book that I will
need to play "catch up." After some business meetings in
Santa
Barbara, I will be in
San
Francisco on January 12 and 13. I
will be traveling with Matt Osborne, the Director of Research for
Altegris Investments. We will be looking at several hedge funds, but
I will have some time to meet with current and potential clients.
I will be in Pasadena and
Long
Beach on the 18th and 19th to
help celebrate Rob Arnott's growth from zip to $1 billion under
management in less than two years. He runs a fund for Pimco that has
been blazing and he deserves the success. I will have some time to
meet with a few people.
I will be in
Miami from February 7-11,
attending the Managed Funds Association Conference with Jon Sundt
and the team from Altegris. We will have plenty of time to meet with
people. The week before, I will also be in
Calgary speaking at private
investment conference for the energy investment banking firm of
Peters and Company at Lake
Louise, and I will be taking
my bride to get away for a few days.
It has been a great
holiday season with lots of kids and friends, and this weekend is
the last of period, as I get back into full swing on Monday, after
my annual doctor's appointment, where he will hopefully once again
tell me all my aches and pains are simply getting older and that I
am in great shape.
Here is wishing you a happy and
prosperous New
Year. |
