Housing Market: In Recovery Mode or Not?

One of the key questions both economists and investors have to ask themselves is whether the U.S. housing market is finally in recovery mode or still just half way through a lost decade, with home prices already down a third from the 2006 peak?

The answer to this question is important to the future of the American economy, at least according to the International Monetary Fund (IMF). It said recently that the housing market is vital to eventually boosting economic growth and reducing high levels of unemployment in the United States. The IMF forecast that there will be a need for about 1.5 million homes to be built annually over the next five years. One of its economists, Gian Maria Milesi-Ferretti, said "it [housing] is clearly going to be something that will help U.S. growth over the medium term."

And indeed there are signs of recovery from the bottom in the housing market. Home prices (Case-Schiller home price index up three months in a row) and new home sales (up about 20% from a year ago) are on the rise. Inventories of unsold homes are also declining thanks largely to record low mortgage interest rates. Additionally, the latest National Association of Home Builders' housing market index rose solidly in all regions of the country to an overall 35 reading in July, a five-year high and well ahead of expectations. The monthly gain from June's 29 reading was the largest in almost 10 years.

As usual, Wall Street momentum players have jumped well in front of what they perceives as a trend, pushing the prices of home building stocks up until they are on pace for a record year. Goldman Sachs recently upgraded the sector to 'attractive'. The Standard & Poor's Supercomposite Home Builders index is up about 50% so far this year, which is nearly five times the gain of the S&P 500 index. Among the leaders in the index are PulteGroup (NYSE:PHM), Lennar (NYSE:LEN), Toll Brothers (NYSE:TOL) and DR Horton (NYSE:DHI). Publicly-listed homebuilders make up about a quarter of total new home sales in the United States and that percentage is rising every year.

However, Wall Street may have jumped the gun. After all, this not your father's housing market; great shifts in the U.S. economy over the last 10 years have changed housing market dynamics for good. Among the factors affecting today's housing market is the fact that many homeowners are still "underwater" on their mortgages. Add to that 15 years of stagnant or declining income for many households and the record levels of student loan debts – more than $1 trillion – and you have a scenario which acts as a brake on household formations via younger people buying houses. First-time home buyers in 2011 made up only 37% of home purchases versus 51% in 2010. Stringent mortgage requirements by banks are also a major factor behind the drop in first-time home buyers.

Take a look at the obstacles that recent college graduates – the largest group of first-time home buyers – face. They are starting out as the most indebted generation of Americans ever, with an average of $25,000 in student loan debt. They are entering a labor market where the number of people with jobs is at a 30-year low, wages are falling in many sectors, and those with jobs face decreasing health and retirement benefits. None of these factors are conducive to making young people run out and buy a home.

The basic fact is that the housing market and income generally move in lockstep with each other, and real median household incomes of Americans are still stuck at the same level they were under the Clinton administration in 1996. This means that the housing market will remain troubled for "an extended period of time," according to senior economist at housing data company CoreLogic, Sam Khater, in an interview with Reuters.

Pulte's CEO Richard Dugas told Wall Street analysts home sales are still "preposterously low" when compared to historical trends. But at least things seemed to have bottomed, laying a new foundation for the future. Most economists expect home prices to be stable this year and project a modest rise of 2% in prices in each of the next few years. It's a good start, but conditions will likely improve at a more rapid pace in the housing market only if and when the U.S. sees an improvement in its employment situation.

Retail Sales Gain Hints at
Stronger Growth

Retail sales rose in July for the first time in four months as demand climbed broadly for everything from cars to electronics, a sign consumers could drive faster economic growth in the third quarter.

Retail sales rose 0.8 percent last month, the largest gain since February and well above analysts' expectations, data from the Commerce Department showed on Tuesday.

A separate report showed U.S. producer prices climbing in July at the fastest pace in five months even as energy prices fell.

The retail sales data bolsters the view that the slowdown in economic growth during the second quarter will prove temporary.

The report could give some relief for President Barack Obama, whose November re-election bid has been imperiled by a sour jobs market. Republican challenger Mitt Romney is focusing his campaign on the weak economy that has plagued Obama's presidency.

Economists polled by Reuters had expected retail sales to rise 0.3 percent. U.S. stocks opened higher yesterday on the data along with yields on U.S. government debt. The dollar rose against the yen.

Job creation in the United States slowed dramatically in the second quarter as economic growth cooled to a 1.5 percent annual rate. In June, sales at U.S. businesses slipped the most since March 2009, the Commerce Department said in a separate report.

Still, some economists think data showing stronger exports will lead the government to revise upward its estimate of growth during the second quarter.

Hiring picked up last month although the unemployment rate still rose to 8.3 percent.

Pointing to a strong increase in consumer spending in July, the so-called core measure of retail sales - which excludes autos, gasoline and building materials - rose 0.9 percent. That was the biggest gain since January.

Strength in consumer spending could help corporations doing business in the United States. Home Depot raised its earnings outlook on Tuesday as the world's largest home improvement chain beat Wall Street's profit estimates in the latest quarter.

U.S. Wholesale Prices Rise Slightly in July

According to the Labor Department, wholesale prices in the country rose 0.3% last month as higher food costs offset another decline in energy costs. Analysts surveyed by MarketWatch expected a rise of 0.2%.

Core producer prices, excluding volatile food and energy, rose 0.4% — higher than analysts' expectations of a 0.2% increase.

The July gain in PPI was the largest since February. In June, the headline PPI rate had risen 0.1%, while the core rate had risen 0.2%.

The severe drought in the Midwest appears to already be hitting prices.

Wholesale food prices in July rose 0.5% for the second straight month. Corn prices rose 34.5%, the biggest rise since October 2006.

But analysts have been playing down how much higher food prices will impact inflation.

"Historically, food prices have not been a significant driver of U.S. inflation compared with energy or core prices," said Peter Newland, an economist at Barclays Capital, in a recent research note.

Wholesale inflation has been trending lower in recent months.

In the 12 months ending in July, producer prices rose 0.5%, the smallest gain since October 2009. The annual inflation rate peaked at 7.1% in July 2011 and has been falling steadily ever since.

Minus food and energy, those prices have climbed 2.5% — the smallest year-over-year gain since June 2011. The core rate peaked at a 3.1% rate in February and has since turned lower.

Energy prices fell 0.4% at the wholesale level in July, data showed.

Prices for intermediate goods fell 0.9% in July, as energy goods fell 1.6%. This offset a 1.4% gain in intermediate foods and feeds prices. Excluding food and energy, prices for intermediate goods fell 0.9%, the largest drop since December 2008.

Prices for crude goods climbed 1.8% and crude foodstuffs rose 5.2%. This was the biggest increase in crude food goods since February 2011.