The housing collapse shows no signs of ending and the economy has either entered a recession or will do so shortly. While the unfolding events are coming as a surprise to most, Comstock saw the potential danger over three years ago. Although we were far too early, here is what we said on September 22, 2003 in the conclusion of our report. (See Special Report: "Potential Catalyst-Real Estate" in the box on the left of our website home page--the charts used in that report were just recently updated. Note in the seventh paragraph our amazement that the Fed Chairman would actively promote reckless borrowing by homeowners).
"In summary, we believe that real estate will be the main catalyst for the deflationary environment we expect is inevitable. This is the result of the tremendous demand for RE since the mid 1990s driving valuations through the roof. The prime driver of the appreciation was the liberal lending policies of banks and mortgage institutions. The combination of the lax lending and the demand from homeowners to continue to borrow against the equity in their homes, have placed RE in a vulnerable position. The rising prices have moderated substantially, while until just recently the borrowing and lending continued at record levels. This dropped homeowners’ equity to record lows. Since every valuation ratio of real estate is presently at record highs, if the slowdown in appreciation turns into an actual decline in values, the present economic recovery and stock market recovery could reverse and be potentially devastating to the financial environment."
Now the chickens have come home to roost. The housing situation continues to deteriorate with no end in sight while a recession of yet unknown magnitude has probably started. Furthermore the turmoil in the credit markets shows little signs of being resolved anytime soon.
The NAR reported today that December pending home sales were down 24% from a year earlier, the largest drop in the history of the index. The index is has an excellent record of forecasting existing home sales for the next one or two months. The Case-Shiller 10-city composite home price index is down 8% year-to-year. Inventories of homes for sale, both new and existing, remain at record levels. Builder D.R. Horton reported that its backlog declined 51% from a year ago and that its cancellation rate on new contracts is 44%. The CEO of Centex stated that this will ultimately be the deepest and longest housing correction since World-War II. The CEO of Lennar said that "There really isn’t any visibility as to where the bottom is." Robert Toll of Toll Bros. added ".we are not seeing much light at the end of the tunnel." Despite efforts by the Fed, Congress and the Administration to inject more liquidity into the system we see continued housing weakness as a result of deteriorating credit quality, tougher lending standards, declining house prices and a lack of demand.
The housing mess along with all of the related problems in the credit markets is having a serious impact on the economy. Payroll employment was down in January, and up only 0.7% year-to-year. Employment growth dropped this low only ten times in the post-war period, and each instance was followed by a recession. It is also noteworthy that in non-recessionary mid-cycle slowdowns, year-over-year employment growth never went under 2%. In addition initial unemployment claims have now gone over 350,000 for two straight weeks while the four-week average climbed to 335,000 from 310,000 in October. The four-week average of continuing claims is the highest in four years.
Retail sales, too, are feeling the heat. Year-to-year chain store sales were up only 0.5% in January, the weakest January since 1970, and the slowest growth for any month since 2002. The outlook for consumer spending in the period ahead remains questionable as a result of the aforementioned labor weakness, housing, record household debt burdens, a near-record low savings rate, gasoline prices and the ongoing credit crisis.
In our view it is far too early to look for a cyclical bottom in the market. A recent survey indicates that economists view the chances of recession at only 50%. Since the market can’t discount what it doesn’t even concede as a fact, it is doubtful that a recession has been priced in. Furthermore the last eight recessions have been associated with an average S&P 500 decline of 30% with the market topping, on average, seven months prior to the economic peak, and bottoming seven months after the economic peak and three months before the trough. With today’s S&P 500 close down only 15% from its October peak, we think it is far too soon to be fishing for a bottom.
