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The nearly uninterrupted and intoxicating rise in equities over the last four months has caused many normally sober market participants to underestimate the severity of housing's downturn and to ignore the likely broad multiplier effect of housing's hard landing on the economy.
The arm of the housing market is long, and the cycles (up and down) tend to be long, too. Importantly, the lag of housing's negative influence (from the statistical peak in housing) is typically long, too.
At first, furniture retailers are immediately affected by the slowdown in residential activity -- just look at the rotten charts and continued earnings guidance of furniture industry stocks like
Then home remodeling retailers and appliance manufacturers falter -- just look at the bad chart and profit guidedown at
. Ultimately, the effect that a hard landing in housing has on economic activity -- and the lower home prices that it portends -- broadens and causes a deep retrenchment in consumption (starting at
) , and its scope and impact, as seen by the residential fixed investment to GDP chart (below right), becomes all-inclusive.
The chart clearly demonstrates how atypically strong the recent up cycle in housing was by historical standards (topping 6% of GDP for the first time since the post-World War II expansion), how far we are from a bottom (in residential fixed investment), and it speaks volumes regarding the likely economic slowdown .
Earlier this month, Richard Fisher, the Dallas Federal Reserve's President,
the factors that contributed to the unprecedented boom in housing over the last six years.
In retrospect, the real Fed funds rate turned out to be lower than what was deemed appropriate at the time and was held lower longer that it should have been. In this case, poor data led to a policy action that amplified speculative activity in the housing and other markets. Today, as anybody not from the former planet of Pluto knows, the housing market is undergoing a substantial correction and inflicting real costs to millions of homeowners across the country. It is complicating the task of achieving our monetary objective of creating the conditions for sustainable non-inflationary growth.
Residential Fixed Investment to GDP
Source: Guerite Advisors
Stated simply, too-low interest rates fueled the speculative activity in housing and stretched affordability, which has resulted in an ever-expanding inventory of
. Today, a record level of builders' unsold inventory (including homes not started, homes started but not completed and completed home inventory) coupled with the residue of speculators' unsold homes speaks to a hard landing in housing, despite the protestations of many.
It is no wonder the Bureau of Labor Statistics reported a near 10% decline in home prices last month, and that many
homebuilders are reporting cancellation rates in excess of 40%
The chart also shows that, over the past 60 years, whenever residential fixed investment tops 5.5% of GDP and subsequently falls by at least 10%, a recession occurs (the recessions are depicted in the nonshaded areas of the chart). Already the ratio of residential fixed income to GDP (which peaked at 6.3% in late 2005) has now dropped by more than 10%. According to Guerite Advisors, the ratio has declined by another 17.4% in the fourth quarter of 2006.
Needless to say, there are other housing-related influences that will weigh negatively on forward consumption levels and lead to a period of
) -- adjustable option ARM interest rate resets; a clamping down on creative/aggressive financing (as defaults/delinquencies grow); the absence of personal savings; still-stretched affordability ratios of home prices to household incomes, etc. -- that suggest the housing landing will be hard, serving as a strong headwind to economic growth by weighing on the consumer and countering the relatively stronger position of the corporate sector.
Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd. Until 1996, he was senior portfolio manager at Omega Advisors, a $4 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a general partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box."
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