Bill Cara: New home sales suffer worst drop since 1994, Fri., Dec. 23, 2005, 2:59 PM

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December 23, 2005

New home sales suffer worst drop since 1994, Fri., Dec. 23, 2005, 2:59 PM

The U.S. housing boom may be over. The year 2005 will go down in the record books as a record, but traders must look what happened to this market after mortgage rates rose in July. We previously saw that August and September were weak months, and by averaging out the big gain in October with the plunge in new home sales reported today for November, the past two months have not been impressive either.

Clearly, the tipping point was reached as mortgage rates rose in the 3Q05. Should rates increase further in 1Q06, buyers will disappear.

Today's data shows that the inventory of new homes on the market has gone from a supply of 4.3 months a year ago to 4.9 months today. Further increases in mortgage costs will remove demand and increase supply.

There are experts today who believe that the market will take as much as five years to stabilize, during which time we should expect generally flat to falling prices, particularly in the over-priced California coastal market, and in NYC-New England, the mid-Atlantic states, and South Florida.

This is a good sign, I think, for bonds, but you know that it was the wealth effect of the housing market that has supported the growth in the U.S. economy and stock market in the past year. At the end of Jan-06, should there be further weakness in the reported December U.S. housing data, that would be a major negative for the U.S. economy and the coup de gras in terminating the 2002-2006 bull market.

Of course, with the amount of research done being today, this trend reversal would already be known, and starting to be priced into the stock market early in January. The first losers would be the California regional banks, the mortgage lenders, and the consumer sector, which needs a healthy economy to support the earnings growth priced into stocks at these levels.

Traders will be watching the flatness and possible inversion of the U.S. Treasury yield curve as an indicator of economic weakness and possibly recession. They will also be watching the level of real estate foreclosures as well.

Posted by Posted by Bill Cara on December 23, 2005 02:59:51 PM | Category: Cara Today in the Market , Economics

Discourse

Well, the yield curve it seems has now spoken.... An ominous pre-holiday gift...?

The repatriation of dollars does indeed contribute to the growth in M3, but hardly explains the whole of it. It is estimated to be about 200 billion.

Bill -- do you think that the markets have fully recovered from the technical damage done in Oct.? Or is there still a significant degree of residual damage there, in your opinion?

Posted by: rhetguy at December 23, 2005 5:58 PM [link]

Are homebuilders continuing to build inventory? The building permit data suggest that is so. Why would they do that unless they knew demand would be there? Or do they have a choice?

As insiders sell millions of dollars of company stock (see TOL, LEN) is it likely they come out and declare 'we will cut revenue (new home sales) by 50% until demand comes back'? It would be difficult, they have been drinking the wall street cool aid so long that they may be addicted. If unsold home inventories continue to rise AND uneployment levels begin to rise in 2006... it could mean a difficult adjustment to the American Dream.

An asset bubble such as real estate is self reinforcing as debt creation impacts the collateral value. Rising collateral values makes more debt possible, a virtuous cycle until it stops. Eventually regulators have to stop these types of cycles (tech was also a self reinforcing cycle / bubble) as they end badly. The greater the debt involved and the greater the distortion in investor expectations... the greater the risk of financial disruptions in the system.

Some look on the Fed as being almost god like in their ability to navigate the cycles. I suspect they are actually human. However, if we are nearing the end of a very long expansion in debt affordability (and therfore growth) they may need those god like powers more than at any time in recent history.

2006 will be interesting, no doubt.

Posted by: stockman at December 23, 2005 6:39 PM [link]

stockman-
The home builders continue to build. Most don't look out very far. The smaller ones are especially unsophisticated and they are a large part of the market. They have purchased their land and ordered their materials. It takes a while to stop.

Posted by: MarkM at December 23, 2005 7:17 PM [link]

Hi Bill:

Just wanted to pass on an article relating to the U.S. housing industry and its link to economic growth. The numbers are stunning:

The article is from the Wall Street Journal that was posted on the Big Picture website. The article reviews a study of mortgage-equity withdrawal(MEW) and the real estate industry by Goldman Sachs:

Some quotes:
"Jan Hatzius, a Goldman Sachs economist, estimates Americans will withdraw $834 billion from residential real estate this year."

"According to Moody's Economy.com, the real-estate industry is responsible for creating 1.1 million of the two million net jobs that the nation added in the five years that ended in October."

"Goldman's estimates were that consumers spend ~68% of the cash they extract through home-equity loans and refinancing (most of the rest is used to pay down credit-card debt or invest)."

Link: http://tinyurl.com/cbhyk

Fed Chairman Alan Greenspan himself co-authored a report in October and found that the combination of home equity lines of credit, capital gains from home sales and mortgage equity cash-outs added about $700 billion to economic activity last year, which is incredible.

If the housing boom is indeed over where will the growth in GDP come from? 2006 should be an interesting year.

Posted by: JIM at December 23, 2005 11:20 PM [link]

Speaking of the Big Picture, did you catch Barry's Business week 2006 outlook? His year end target of DJIA 6800; year end long bond 3.25%; favorite stock GLD. Not a main stream view, my kind of guy.

http://bigpicture.typepad.com/comments/financial_press/index.html

http://www.businessweek.com/magazine/content/05_52/b3965416.htm

Posted by: stockman at December 24, 2005 7:10 AM [link]