Housing – Wall Street’s Kryptonite

by Michael Shulman | April 12, 2011 10:01 am

No rational person could think the housing market will somehow magically “repair itself” anytime in the near future. Today we’ll examine the current stagnation to see why economic growth will continue to stall — barring intervention by Federal Reserve Chairman Ben Bernanke — and look closely at the housing market as the catalyst for current and future market conditions.

In the United States, a broken housing sector must, by definition, mean a significantly underperforming economy — and that, in turn, will hit corporate profits before year-end.

Of the jobs created between 2002 and 2007, 40% were linked to residential construction. And current homebuilding is off its peak by roughly 80%.

Consider that:

No Light at the End of the Driveway

The Great Market Crash of 2008 and the Great Recession that followed were brought on by the Great Housing Depression — and it’s far from over. Housing is critical to the economy, consumer spending, corporate profits and the market. Here are some statistics:

Housing starts created up to 40% of the new jobs between 2002 and 2007. These jobs were particularly tied to residential construction.

Many of these jobs employed people with lower-level skills who were displaced from the lower-end jobs that have been steadily going overseas to factories in China, Vietnam and elsewhere. For example, a drywall hanger doesn’t just upgrade his or her occupation to the more readily available skilled jobs. With housing starts down more than 80%, these people are unemployed or underemployed.

Also, housing price appreciation creates real and perceived wealth. When you look at your mortgage statement, and know the next-door neighbor sold his house for 40% more than you owe, you have real potential wealth built into your property — i.e., some money in the metaphorical “piggy” bank that is your home.

If, instead, you find out your neighbor sold his house for about what you owe on your mortgage or less, you tend to lose your optimism, become more cautious and hold on to that car you were going to trade for another year or two, and put off other elective purchases.

And housing prices are continuing to fall. The leading gurus on this topic, the data people at Case-Shiller, showed this in the home prices survey released late last month. They stated, “The housing market recession is not yet over, and none of the statistics are indicating any form of sustained recovery. At most, we have seen all statistics bounce along their troughs; at worst, the feared double-dip recession may be materializing.”

Finally, the income and wealth lost from the one-third drop in housing prices has hit consumer spending hard and will continue to do so.

The Looming Wave of Foreclosures

Housing prices continue to fall because of the great and growing imbalance between supply and demand. It’s a problem that can’t be fixed by the government, or anyone else.

The current inventory of homes on the market is not only high by historical standards, but getting bigger every day. Foreclosures have flooded the market with homes, and there are 7 million or more foreclosures yet to happen during the next three years. According to data from the March 2011 LPS Data Monitor:

Predicting foreclosures is relatively straightforward using the data about homes underwater, delinquency rates and days past due.

And the government programs to reverse this are simply ineffective. Even the two-thirds of the homeowners who are able to stay in their homes through some sort of government intervention end up in foreclosure anyway.

Home Buyers Missing, Renting

On the other side of the equation is demand, and sadly there is little of that going on:

We can expect this massive housing problem not to begin to clear up until home prices stabilize — something that isn’t expected to happen before late 2013 or early 2014. What does that mean for consumer spending, the economy, profits and the market?

Consumer spending is headed for stagnation and/or a fall. The latest Conference Board survey data showed a sharp drop in confidence in March — from 72 to 63.4 — and confidence is the basis of spending. It fell sharply because of worry about rising prices and stagnant incomes, according to the Conference Board.

Housing Slump to Hit Corporate Profits

As spending stalls and/or declines, corporate growth does the same, except for some big exporters. And with the stagnation or decline of corporate growth, there will be a decline in corporate profits.

While most analysts believe estimates for the S&P 500 are achievable in 2011, I believe the estimates are way too high for 2012. As the market will punish companies that miss or downgrade forecasts, a correction is in store based on a revised outlook for 2012.

The only thing that would prevent a downward move by the market, in general, is another round of quantitative easing by Bernanke and the Fed. As it is, if the economy appears to be on track in June, QE in its current form will end.

On the other hand, if the economy hits a noticeable roadblock before then, Bernanke will be able to justify more QE. And QE is key, because you can’t fight the Fed. The massive liquidity produced by the Fed has been designed to raise asset prices (something it has done), and if it continues, it’s hard for me to envisage the market falling despite problems with corporate profits.

That being said, the betting money on Wall Street believes that quantitative easing will end in June, and it probably will. Then, when the economy stalls, it will lead to a disaster.

When it becomes clear that the Fed isn’t going to immediately ride to the rescue once again, the stock market will tumble.

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