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Jubak's Journal Recent articles: • 5 money-in-the-bank stocks, 1/25/2006 • 6 ways to invest in the coming coal boom, 1/24/2006 • Buyout boom's next phase: greedfest, 1/20/2006 More... | Jubak's Journal The housing bubble is deflating -- but gently So far, there is no resounding POP to the bubble. But a closer look at home-sales numbers reveals danger signs in a few markets. By Jim Jubak As Edward G. Robinson said in "Little Caesar," "Mother of mercy! Is this the beginning of the real estate bust?" (Well, he would have said that if he wasn't playing Rico, a Depression-era gangster.) Sure looked that way Wednesday. Sales of existing homes dropped by almost 6% in December from November's pace, according to the monthly survey by the National Association of Realtors. That's the third straight monthly decline in sales of existing homes. The median price of a house fell by almost 2% from the previous month. As you'd expect -- especially since the drop to an annual sales rate of 6.6 million was worse than the 6.9 million annual sales rate that economists had been expecting -- the news knocked the stuffing out of housing stocks. The Ryland Group But although the data do show a continuing slowdown in the housing market, in my opinion the numbers don't add up to anything like a bust.
So far, what we're seeing is a gradual deflation of the housing bubble thanks to higher mortgage rates. The danger signs, if they do exist, are local and concentrated in what had been the hottest housing markets. And there's certainly no evidence, so far, of any national mortgage debt crisis. Nationally, borrowers are actually showing lower default rates. (In some local markets, default rates are rising, but the troubles in the local economy seem to be the culprit.) That last point is important, because it would take soaring mortgage and home-equity loan default rates in order for any correction in the housing market to do damage to the financial markets at large. Related news and commentary on MSN Money
A bubble deflates, gently At the moment, in my opinion, the numbers tell us to stay vigilant and watch trends carefully. So far the Federal Reserve, which created this housing bubble, is being successful in its efforts to deflate it gently. I'm skeptical that the Fed's efforts will have a happy ending in the long run, but I don't see any reason to panic before panic is due, either. Let's take a closer look at the data, shall we? Yes, December sales of existing homes were down from November. But sales for 2005 still set a record at 7.1 million. That's up 4% from the 6.8 million homes sold in 2004. We're still a long way from seeing an actual year-to-year decline in sales of existing homes, although some economists are expecting to see exactly that in 2006. David Lereah, chief economist for the National Association of Realtors, projects 2006 sales of existing homes to fall by 5% this year. A 5% drop would result in sales of 6.7 million existing homes in 2006. That's justly slightly below the 6.8 million sales in 2004 and still 8% above the 6.2 million sales in 2003. For the gradual sales decline of the last three months of 2005 to become something more serious, the rate of decline would have to pick up in 2006. And it's certainly possible that it will: The supply of unsold existing homes moved higher in December. The inventory of unsold houses now equals 5.1 months of existing sales. That's the highest inventory level since June 2003. The downward spiral I think one of two things has to happen for the rate of decline to accelerate. First, the drop in the selling price of an existing house needs to become large enough -- and the speed of decline fast enough -- to send both buyers and sellers to the sidelines. Clearly, the West, the region that has been the hottest market in the country during the housing boom, is the market to watch. Sales of existing homes in the West fell by more than 11.4% in December. That's twice the national rate. And the median selling price of a house in the West fell by 4.5%. That's way above the 2% drop in the median sales price in the Northeast, the other hot market in the recent boom. Another few months of that kind of sales-price decline might be enough to take buyers out of the market: Who wants to buy a house today when it will be cheaper tomorrow? That would accelerate the decline in sales, which would, in turn, lead to further price drops, which would, then, accelerate the decline in sales. Second, the economy could soften enough so that buyers would be either unwilling to buy because their own economic situation is so uncertain, or unable to buy because of lost jobs or income. I'd look to the Midwest as a test case for how a soft economy accelerates a drop in existing home sales and exerts strong downward pressure on housing prices. After all, the region's economy is taking a huge whack from the troubles of the auto industry, the area's biggest industry. Ford Motor In December, amazingly to me, you don't see much sign of those troubles in either the numbers of existing homes sold or in the median price of those sales. Sales of existing homes in the Midwest dropped by just 2.6% in December, well below the national average of a 5.7% decline. And the median sales price in the Midwest actually climbed by 1.7% in December. The Midwest was, in fact, the only region to show a rise in median sales price in December. That doesn't mean there isn't trouble in the housing markets of the Midwest. Just that the trouble isn't showing up -- yet -- in the numbers for sales of existing homes. Pain in the rust belt The pain is showing up, however, in the default rates on mortgages, credit cards and other forms of consumer debt -- especially in what are called the subprime markets, where borrowers have less than sterling credit ratings. In October, the national default rates on credit card receivables and auto and mortgage loans fell by 11%, 2.7% and 7.9%, respectively, according to an analysis by Friedman, Billings, Ramsey. That's good news for anyone who's worried about the ability of the U.S. consumer to carry current high levels of indebtedness. But in 56 metropolitan areas in 16 states, default rates are well above the national average. Default rates for prime and subprime loans in these areas were 3.23 and 2.2 times higher, respectively, than the national average. And where are these high-default metropolitan areas located? Well, they correlate pretty closely with the auto industry. The industrial belt from Indiana through Ohio into Pennsylvania and western New York is dense in high-default areas. Cities such as Akron, Ohio, Buffalo, N.Y., Flint, Mich. and South Bend, Ind., make the list. (I haven't done a complete breakdown of the list, but I suspect that many of the cities in the South that qualify are or were home to auto plants.) And this was in October 2005, before the big job cuts of the most recent round of cutbacks hit. Friedman, Billings, Ramsey believes that default rates correlate very closely with economic growth -- or lack of it, actually -- and they've projected recent trends out into October 2006. Default rates in the 56 currently high-default metropolitan areas will climb to 14.5% on subprime loans from the current 13.8% rate. For reference, the current national average default rate on subprime loans was 6.16% in October 2005. In these areas, as workers lose their jobs and as hours and hourly wages are cut, people will increasingly lose their homes, as well. I'd expect that will have a negative effect on housing sales and sale prices in these individual markets. Not having any money in your pocket or wondering where your next paycheck is coming from will tend to do that. The Midwest as a preview scenario Fortunately, as the economists and the Wall Street investment strategists tell us again and again, housing markets are local. So the pain in the Midwest (and South) created by the jobs hemorrhaging in the U.S. auto industry isn't a problem for those of us who own homes in other parts of the country. Unless, of course, you happen to believe that what's happening to the U.S. auto industry is part of a pattern that stretches across the entire U.S. economy, just not as visibly. Higher wage jobs are replaced by lower wage jobs with fewer benefits that add up to less health care and lower retirement incomes. Then what's happening in the Midwest is a kind of preview for what we might all face when the economic cycle turns, as cycles always do, or when the cold calculus of the global economy turns its attention to your industry or mine. Of course, by that time we should have enough data from the Midwest to know exactly how badly an economic decline affects home sales and sale prices. That makes me feel much, much better. New developments on past columns "3 stocks riding the big trends of 2006": Conergy Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For suggestions to help navigate the treacherous interest-rate environment see Jim's new portfolio Dividend stocks for income investors. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Conergy. He does not own short positions in any stock mentioned in this column. | |||||||||||||||||||||||||||||
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