Economic Fundamentals Slipping Away

While it is now clear that we are in regional recessions, the poor performance of many of our market indicators over the last several months supports speculation of a national recession. Our overall grade for the health of the U.S. housing market has slipped to a D+. Our U.S. Building Market Intelligence grades for each sector over the last 10 months includes a prominent decline in the New Home and Housing Supply. Mortgage rates have been the lone sector to perform at an above-average level. If we could track Debt to Income and Loan to Value ratios, our mortgage rate grade would not look as good.

Economic Growth………………………………………………………………….C-
Employment growth fell further, dropping to year-over-year growth of just 810,000 payroll jobs, or 0.6% growth. Despite the slowed growth, unemployment fell slightly to 4.8%, but mass layoff events during the month of January were 15% higher than one year prior. Personal income growth fell sharply to a 2-year low at 4.9%, and retail sales growth has dipped to 3.9% year-over-year, far below its historical average of 5.6%. Core CPI – a key gauge of inflation – increased in January to 2.5%, the highest value since March 2007.

Leading Indicators…………………………………………………………………D+
Nearly every one of our leading indicators experienced deterioration this month, suggesting continued economic difficulties in the near future. The Leading Economic Index has declined at an annualized rate of 4%, which is the lowest rate in 7 years. Each of the 4 major stock indices we track fell 3-5% sequentially, and have shown zero to negative returns over the last year. Rising oil prices continue to tighten consumers’ wallets, with crude oil at $95.35 per barrel for February, and rising even higher in March. The Institute for Supply Management reported contraction in the manufacturing sector, as indicated by the declining ISM Purchasing Managers Index, which this month measured the lowest reading since April 2003. Non-manufacturing business activity improved slightly this month, following the first contraction in nearly 5 years in December, but still remains far below its historical average.

Mortgage Rates…………………………………………………………………….B+
Though mortgage rates remain relatively low in comparison to history, a more rapid increase in fixed rates widened the spread between fixed and adjustable rates to its highest level in more than 2 years. Despite an easing of the Fed Funds rate of 125 basis points in January, the 30-year fixed rate jumped 52 basis points during the last two weeks of February, reaching 6.24% by month-end. (It has since retreated 20 basis points.) A slower rate of increase in the adjustable rates resulted in an increase in the percentage of ARM applications to 15% of all loans originated, according to the Mortgage Bankers Association. The performance of subprime loans issued in the first half of 2006 continues to weaken, as measured by the ABX 06-2 BBB- series index, which has declined 81% in the last year.

Consumer Behavior………………………………………………………………C-
Consumer behavior was weaker this month, as consumer confidence took a nosedive to 75, well below its long-term average of 98.5. The University of Michigan’s Consumer Sentiment Index declined to 70.8 in February, which is its lowest value in 16 years, and remains much lower than its long-term average. The Consumer Comfort Index fell to its lowest monthly average in the history of the index, based on respondents’ impressions of the national economy, personal finances and buying climate.

Existing Home Market……………………………………………………………D
Continued weakness persists in the existing home market this month, with few signs of improvement. Annualized existing home sales decreased to 4.89 million in January, representing a 23.4% decline in the last year, and a declining pending home sales index suggests that sales may fall further. Prices in the resale market have fallen 5% year-over-year, according to the National Association of Realtors. The level of existing home inventory rose to more than 10 months of supply, with 4.2 million homes for sale. The homeownership rate fell to 67.8% in the fourth quarter, following a steady decline after peaking above 69% in this cycle.

New Home Market…………………………………………………………………F
The new home market remained extremely weak this month, as sales activity and prices continue to decline while inventory levels rise. The NAHB’s Housing Market Index, which measures new home sales and traffic, measured in at 20 this month, up from 19 in January, but still near its historical low. New home sales activity fell to 588,000 annual transactions, declining 34% year-over-year and 58% from its peak volume in July 2005. The level of unsold new homes increased to nearly 10 months of supply, which is the highest since October 1981. This includes approximately 4 months of unsold completed new homes alone. The Census Bureau reported that the median new home sales price of $216,000 represented a 15% decline over last year, which is the worst year-over-year decline on record.

Housing Supply…………………………………………………………………….F
The supply of housing continues to decline, remaining at very low levels. The annual volume of new home completions experienced a marginal increase to 1.35 million, which is the lowest total since August 1997. Housing starts stayed relatively flat this month at a little over 1 million total annualized starts and remains the lowest since 1991, indicating that completions are likely to continue to decline in the near future. The single-family permit volume fell 40% in the last year alone, dropping to 673,000, which is the lowest volume since early 1991. The number of multifamily permits also fell, and the total seasonally adjusted permit volume has fallen to about 1 million, which is the lowest volume since November 1991.

If you have any questions, please contact Chris Porter at (949) 870-1218 or by email.