The Housing Market Is Stabilizing
06/30/09
I am quoting out of context but I just loved this quote from this weeks Wall Street Journal, in which Mark Gongloff discussed recent inflation fears " ... But a funny thing happened on the way to Zimbabwean hyperinflation: People started buying Treasuries again, raising prices and pushing yields lower." You may remember that I do not agree with certain people on Wall Street who think that inflation is right around the corner. Why would money managers commit billions of dollars for ten years or more at less than 4% when they expected inflation to rise? They would not, if they valued their job. No, we may have to worry about inflation in a couple of years – if we are lucky. Until then, there are plenty of other problems to loose sleep over. Take the housing market for example. It was the symbol of the American Dream, but then turned into the Highway to Hell. The S&P/Case-Shiller Home Price Index was published yesterday and showed further deterioration in the 20 largest metropolitan areas. The release represented the housing prices for the month of April, which is already 2 months past. It is an unfortunate fact, that the methodology requires the gathering of a lot of data, which naturally takes a while to assemble. The index therefore does not give us a June reading until the end of August. There is however home price data from the National Association of Realtors. Their website already published May data last week. Let's take a look.
The first Chart shows the Case-Schiller housing index, which measures home prices in the biog cities. At -18.1% year over year change, the index was in line with expectations and showed a very slight improvement over the prior month. Certainly not a good number but not worse than expected, the reading indicates that the rate at which house prices are falling has slowed. I have marked in grey the false housing bottom of summer 2008, which fooled me also. The annual rate of change at least has flattened out (here I go again). The second chart represents the NAR data, which are more encompassing and also represent rural areas, which were never that affected by the housing boom and subsequent bust. Whereas the big cities showed continued price declines in April, the broader market as a whole has started to stabilize several months ago. Only the western part (California mostly) continued to show price declines. Both the Southern part of the US, with Florida being the former center of real estate speculation and the Midwest, hit the hardest by the loss of manufacturing plants and high unemployment, are showing price improvement. This is important for the banks, because they are finding out that not all real estate that they had to foreclose on will automatically decline in price. Banks no longer have to dump inventory indiscriminately. Their recent capital raising efforts and stabilizing home prices make it possible to liquidate inventory more prudently and systematically. That fact creates breathing room and may help many of them to survive this storm. It may be no coincidence then that 10 banks that had received TARP funds from the government paid it back in June. The political strings attached had been severe and at the same time the bankers may have sensed that the endless decline in home values have come to an end. Stable home values are all that the banks need to earn their way out of the hole. The current yield curve structure is enough to generate vast profits. Banks with large deposit bases can pay 1% on savings accounts, 2% on CDs and then turn around and lend ten times the amount of those funds at rates ranging from 6% to 16% depending on the product. Indeed, the current yield curve structure is a bankers dream. I am not predicting a new housing boom. I would not buy any homebuilders either. What I am saying is that many banks with large and stable deposit bases and solid franchises can be viewed as growth stocks in an environment where true growth is hard to find. In the short term, all these assumptions however depend on the housing market. The potential earnings power of bank i.e. high profit margins can only work its magic if and when the housing market stabilizes. There are the usual counter-arguments like "banks are holding back inventory because they do not want to pressure the market further." True. But why dump inventory if you don't have to? The demographics of this country are working for anybody who can hold on long enough. Let me explain by showing you two simple charts.
The population of the United States grew between 1960 and today by roughly 127 Million people. That amounts to an annual population growth of 2.5 Million. All these new people need shelter, which they either rent or buy. The second chart shows you the housing starts as a seasonally adjusted annual rate. Starts are running substantially below the level needed to keep up with household formation and have reached the lowest point in 50 years. Actually, starts are running at half the rate of 1960 even though the population in 1960 totaled 180 million versus 306 million today. This development will keep home inventories on a downward track. Inventories of new homes are already at a level considered normal, having fallen to a seven-year low of 311,000 from a peak of 572,000 in July 2006. Now that fewer homes are hitting the market for sale, the growing U.S. population will have fewer homes to choose from. This will accelerate the recent decline in home inventories which seems to have a positive effect on prices already. Doubters on the inventory idea will surely point to the difficulties that prospective homeowners face in obtaining credit to purchase homes. But they ignore the most important concept, which is to compare the net change in the housing stock to population growth and household formation. Housing starts have now fallen to levels well below what is needed to support population growth. Whether people can afford to purchase a home or obtain the credit necessary to do so is not as important as the fact that they need shelter and will rent space if necessary. The bottom line is that empty homes will become occupied one way or another so long as builders under-build relative to population growth. Keep the metrics in mind: The U.S. population increases by about 2.5 million per year. Household formation will average 1.2 million per year, although it tends to slow during recessions for obvious reasons. The current level of starts yields very few new shelters -- say 350,000 or so -- as many of the homes started are restarts -- homes rebuilt following damage from teardowns, and storms and such. Comparing the figure to population growth and household formation makes one thing clear: Inventories are headed down and the negative employment effect may dissipate over time. Who knows, perhaps the housing industry might even contribute jobs to the economy in 2010. Low interest rates and time is all we need right now.
Hermann Vohs
"The White House: I don't know whether it's the finest public housing in American or the crown jewel of the prison system."
Bill Clinton
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
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