Housing Market Recovery

by Charles N. Waterhouse, Vice President & Senior Financial Advisor 

Spec House – (def.) A residence built without a particular buyer in mind or under contract, but designed to appeal to the maximum market possible.

My wife and I were taking a walk on a recent evening, discussing events of the day.  As we turned the corner into a new neighborhood, there it was!  A newly finished home in an adjacent subdivision, with no landscaping, but a prominently placed “For Sale” sign in the front yard.  It’s a spec house, I thought.  The first one I had seen in 5 years, easy.  It is a clear sign that the housing market is improving. The recent Case-Shiller Index results have signaled a continued recovery in the housing market, as has the rise in housing starts.  A spec house confirms this and shows that builders are willing to take risks again, as demand for housing continues to build.

The US economy continues its slow but steady recovery, and for the last year, the housing market has been a positive contributor to that recovery.   The latest Case-Shiller Index showed that property values in March grew 11% from the year before.  That is the largest year-over-year gain in seven years, and continues a 10 month trend. (Developed in the 1980’s by three economists; Allan Weiss, Karl Case and Robert Shiller, the Case-Shiller Index measures changes in the prices of single-family houses that have been previously sold, in twenty major metropolitan areas.  New construction is excluded.) This accelerating growth has sparked some debate that the Fed may be creating another housing bubble with strategies it’s using to keep interest rates historically low.  But while home values are rebounding, we must remember some markets saw very deep declines during the recent recession.

   Markets Included in the Case-Shiller Composite Index
Atlanta Boston
Charlotte Chicago
Cleveland Dallas
Denver Detroit
Las Vegas Los Angeles
Miami Minneapolis
New York Phoenix
Portland San Diego
San Francisco Seattle
Tampa Washington D. C.

Housing starts and building permits confirm that the housing market is in recovery.  Both have broken through the million unit level in the latest quarter, nearly doubling in the last two years.  While they’re still significantly below their long term average, the trend indicates that demand for housing is increasing and inventory is decreasing.

Economic Outlook

Despite improvements in the housing market, U.S. economic growth appeared to be slowing in recent months.  We saw a strong 2.4% GDP growth in the first quarter of the year, but a delayed reaction to tax hikes and the sequestration cuts to Federal spending may be accounting for the recent slowdown.  These pressures should begin to ease in the second half of the year, which should translate into a pickup of GDP growth.

With forecasts for the economy improving, the Federal Reserve will likely reduce the current Quantitative Easing strategy, which has been adding much needed stimulus to the economy.  As they begin to discuss the reduction of the $85 billion monthly bond purchases known as QE3, the markets are reacting to the unknown consequences.  When Fed Chairman Ben Bernanke hinted at a reduction to QE3 in a press conference following June’s FOMC meeting, the stock market fell 4% and the 10-year Treasury yields shot up to over 2.5%. 

The prospect of the Fed reducing stimulus to the economy confirms that the economy is actually doing better and won’t need the added help going forward. An improving economy should mean consumers spend more, which translates into increased corporate profits. Both are positives for continued growth in stock prices.  Others see an eventual increase in rates and a less accommodative central bank. In any event, it will take the Fed well into 2014 before they can unwind QE3 and be in a position to begin to increase rates.

As we reported previously, we have developed a dual strategy for the current low interest rate and impending rising interest rate environments.  When interest rates start to rise later this year or early next year, we’ll move from longer duration, higher risk exposures to shorter duration investments for protection.