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Why Housing Still Hasn’t Hit a Bottom

Posted on: August 25, 2008 - Email Article - Printable Version

Vinay Ayala

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We all know that the current downturn started with the collapse of the housing market, which led to the lack of liquidity in the credit markets today. As we slowly start to uncover the problems with what occurred in the past, there are some pundits proclaiming that the housing market has hit a bottom or is very close to it. I think people are subscribing to the notion of “it has gotten so bad that it can’t get any worse,” which any rational investor knows is complete trash. There has not been any significant sign that would illustrate these points to me, that would firm up the long term fundamentals of the housing market. Let’s look at some of the data.

The Situation

New existing homes sales numbers came out today and while they came in better than expected, I would not say the report is anything to write home about. Home sales rose a little more than 3% to 5 million units, compared to the 4.85 million units in June, which was better than consensus estimates. While the number of sales increased the median price of these sales fell 7.1%, more than double the increase in the number of home sales reported. This is simply supply and demand economics at work, as a higher number of inventory continues to flood the market, there simply is not enough demand to keep up with this rising inventory, which now stands at about 11 months of sales. Combine that with much tighter lending standards and you have a huge problem of oversupply that can only be corrected by falling home prices. It is great to sell a large number of homes, but if you are not getting a good price on it, what is the point? It seems to me that there are just some buyers that see bargains in some of these home prices and are scooping them up while they can as they hope for the recovery in the housing market.

For those who are calling for a bottom in home prices, it is that 11 months of supply that will continue to hound the housing market. Back in the 1990’s it took a supply of 8 months in order for a floor to establish in the housing market and there is no reason why we could not use that as a standard today, which means inventories have to decrease by about 30% in order for us to see a significant bottom in housing. That would cause even lower prices, with a strong possibility of higher quantity of sales. And let’s face it that is going to take some time, you can not just get id of 30% of inventory overnight. The following problems in the housing market need to be addressed before we can say the housing market has recovered:

Inventories of homes of less than 8 months
Median Home Prices start to rise again
De-leveraging of household balance sheets as homeowners eliminate debt and increase their personal savings rate
A decrease in overall foreclosure activity
An increase in overall equity as a percentage of household value

From an economic and investment point of view, the depressed housing market will continue to weigh on all factors affecting the economy today, as I do not believe the credit markets can recover without the housing problem being fixed. With commodity prices remaining at elevated levels and high unemployment the consumer will continue to be pressed for the next few months. While the discretionary sector has performed well of late it would not surprise me to see it falter a bit in the coming months as the fundamentals do not seem to support these stocks at current levels. Like I have said before and I will say again, the rest of recession/ downturn, whatever you want to call it, will be dominated by consumer spending or lack thereof. Stay within the defensive sectors and you should be able to limit the downside, if the market does take yet another turn for the worst.

- Vinay Ayala

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