Weekly Markets Commentary - February 22, 2012

David Joy — Chief Market Strategist, Ameriprise Financial

Is housing poised for a rebound?

Just as automobile sales have rebounded since the fall and provided the economy with a much needed boost, might not the housing market be similarly poised to awaken from its lethargy as the spring selling season gets underway?

Given the difficult headwinds still facing the housing industry, the recovery to normal market conditions is expected to be measured. Mortgages are still hard to get. The overhang of foreclosed properties continues to compete with new construction for potential buyers. Unemployment remains high. And confidence in the future remains well below expansion levels.

But in these and other measures of housing activity there is, nevertheless, evidence of incremental improvement.

Just since September, the National Association of Homebuilders Index has doubled, reaching its highest level since June, 2007. Each of the three subcomponents that make up the index has doubled as well, including present single family home sales, single family home sales in the next six months, and traffic of prospective buyers. The NAHB forecasts that in 2012 housing starts will increase 16 percent, new single family home sales will grow by 19 percent, and existing single family home sales will rise by 15 percent.

On this week's economic calendar are January results for both existing home sales on Wednesday and new home sales on Friday. The consensus forecast for existing home sales is 4.65 million units, up from 4.61 million in December. As recently as last July the total was just 4.0 million. The January forecast would represent a 16 percent increase from the July total. The consensus forecast of new home sales is 315,000, up from 307,000 in December, and would represent an 8 percent rise from last August.

A similar improvement has been seen in housing starts, which rose to 699,000 in January, a 19 percent increase from August. Building permits rose by 15 percent in the same time frame.

The fundamental reasons for this improvement are quite evident. The National Association of Realtors reports that its affordability index, a combination of home prices and mortgage interest costs, set a record high in October. And after averaging a rate of 4.46 percent for all of 2011, the latest Freddie Mac commitment rate for thirty-year fixed-rate conforming mortgages is an astounding 3.87 percent.

Freddie Mac also reports that the inventory of unsold homes currently amounts to six and a half months’ supply, below normal market conditions.

Other market indicators suggest a potential backlog of buyer demand. Home ownership rates have fallen since their rise to unsustainable levels during the expansion. The long-term average of household home ownership had been closer to 64 percent before surging to 69 percent in the housing bubble. It has since corrected back toward approximately 66 percent, still somewhat higher than normal but not excessive. Household formation itself fell to just 375,000 in 2010 according to the Census Bureau, the lowest on record, as economic concerns caused many to postpone venturing out on their own. More normal historical levels are in the vicinity of 1.25 million. Estimated formations for 2011 suggest the beginnings of a recovery, to between 750,000 and 1 million.

While there is no doubt that the housing market lurched from a condition of overbuilding and excess demand to a condition of underbuilding and too little demand, the weakness in labor markets over the past four years cannot be overlooked as a primary source of that lack of demand. It is not necessary to look much further than 10 percent unemployment to explain the weakness in housing. But the labor market itself is showing improvement, with the unemployment rate for January having fallen to 8.3 percent, a faster decline than contained in most forecasts. And weekly jobless claims continue to trend lower, suggesting further improvement.

The last piece of the puzzle is home prices. There has yet to be any kind of sustained increase in prices that might light a fire under prospective buyers. The Core Logic Home Price Index fell in December for the fifth straight month. The S&P Case/Shiller indices have been bouncing along the bottom for the past eight months. The Federal Housing Finance Agency Home Price Index showed a modest rise in November from the prior month. But there is also a distinction to be drawn between distressed and non-distressed sales. The latter have been showing some modest price strength, while distressed properties remain under pressure. But in the aggregate, prices remain relatively dormant. This suggests that there is little urgency for buyers looking for a bargain.

One potential wildcard that could create some urgency is the future trajectory of mortgage rates. If rates were to rise, it would likely cause some buyers to pull the trigger. But even here there seems to be a certain complacency. After all, the Fed is saying short-term rates will not likely rise until late 2014, and Operation Twist is likely to keep a lid on longer rates, including mortgages, until mid-year. But what if that complacency is misplaced? What if we have already seen the lows and rates start to rise before long? Credit demand is already increasing and the pace of economic activity is surprising on the upside. The Mortgage Bankers Association reported that applications declined in the week ended February 10, but its index in the first two weeks of February averaged a reading of 806, up from 752 in January and 657 in December.  And what will be the impact on mortgage rates at the cessation of Operation Twist in June?

Record high affordability, pent-up demand, rising employment, and improving confidence all suggest that the housing market should also continue to improve. Whether these same variables have improved enough to result in a significant acceleration in housing activity remains to be seen. The traditional spring selling season is here and we shall soon know the answer.

Important Disclosures: