Housing is the current engine of the US economy. It is responsible for over 40% of recent job creation. Equity extraction is one of the primary ways for consumers to maintain their level of consumption. Therefore, a fall in housing could have a serious detrimental national effect. There is a great deal of speculation about when the housing bubble will end and whether it will end with a slowdown in price escalation or a crash. Regardless of the form, it appears more and more factors are lining up, signaling the beginning of a slowdown.
First, the good news for housing: last month sales of existing homes increased 2%. However, this number is very volatile. It dropped 2.7% the preceding month, and has exhibited a fairly high volatility over the past 12 months. This makes it a fairly poor gage of the overall housing picture.
More importantly is the increase in inventories from the same report. In March, total national inventory was 2,297,000. This number was 2,856,000 last month – a 24% increase in 6 months. It has incrementally increased each month as well, making it appear as though an increasing number of people are looking to sell their houses. The month’s supply of houses has also incrementally increased over the same time from a 4 month’s supply in March to a 4.7 month’s supply last month. The inventory situation does not bode well for the continued price appreciation consumers have come to expect from homes.
More importantly are two factors outside the housing sector. The first was the recent large drop in consumer confidence:
U.S. consumer confidence fell to the lowest since 1992 after Hurricane Katrina devastated the Gulf Coast and pushed gasoline prices to a record high.
The University of Michigan’s preliminary index of consumer sentiment fell to 76.9 from 89.1 in August. The reading compares with the median forecast of 85 in a Bloomberg News survey of 53 economists.
The current conditions index, which reflects Americans’ perception of their financial situation and whether it’s a good time to buy big-ticket items, fell to 97.7 from 108.2 in August. The expectations index, based on optimism about the next one to five years, fell to 63.6 from 76.9 last month.
This drop could be a simple one-month drop related to Katrina. However, the size of the drop is very disconcerting. Consumers would have to have a sharp rebound confidence to return to previous levels. This type of sharp turnaround is unlikely. More importantly is the drop in the expectations index, as this has a direct effect on housing. A house is usually the largest purchase consumers make; they are not going to purchase a house if they think the future is bleak. The drop in the future expectations index indicates a larger percentage of people will most likely put-off buying a house for the next month.
This leads to the second external factor that will negatively impact the housing market: energy prices. Katrina seriously crimped US refining capacity. As a result, the price of fuel derivatives is increasing. Heating oil is 35% higher this October than last October. Natural gas is 44% higher. Unleaded fuel is 50% more expensive. Newspapers across the entire northern US from California to Massachusetts have warned about sharp price increases in heating expenses over the winter. Derivatives prices are likely to remain high over the winter as repairs from Katrina related damage to refineries could take through the end of the year.
High energy prices will harm the economy in two inter-connected ways. First, higher prices will lower consumer confidence or keep it at its current depressed level as consumers feel more and more burdened by this necessary expense. In correlation, the longer energy prices remain high, the more consumers will trim their other expenses and investments – namely housing.
In summation, more people are looking to sell their homes. This will slow price appreciation, probably driving more people to sell their homes, creating an escalating spiral of dumping while prices are still high. Katrina sharply knocked consumer confidence, lowering the possibility that people will be willing to make their largest lifetime purchase. And finally, energy price increases will further crimp already constrained consumer budgets, further lowering housing demand. In short, various elements are lining up to slow the housing market. The main question that only time will answer is the degree of the slowdown.