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Outlook for Interest Rates and Stock Market Upbeat

Prof. Peter Morici - 10/26/2006

Today, the National Association of Realtors reported September existing home sales were 6.16 million, down from 6.30 million in August and down from 7.20 million in September 2005. The consensus forecast was 6.23 million, and my forecast published by Reuters was 6.20 million.

The median price fell to $220,000 from $225,000 reported in August and 225,000 in September 2005.

The inventory of unsold homes was steady at 7.3 million units in September. A year earlier inventory was 4.6 million units. The large inventory of unsold homes indicates the housing market is headed further south.

Home Sales and Prices Will Continue to Disappoint

In August, the Index of Pending Homes Sales Index was down 14 percent from a year earlier. The pending home sales data gauge new contracts for sale, while the existing home sales report closings or consummated transactions. Home sales lag the pending home sales index by more than a month. Hence, the pending sales index indicates that housing sales and prices will continue to disappoint.

The large inventory of unsold homes along with the weak pending home sales index indicate the housing market adjustment will continue through at least the spring of 2007.

Through next spring, home sales are likely continue to be weak, home prices are likely to continue falling, and the number of unsold homes will remain high. Quite simply, the housing market is burdened by a glut of sellers and shortage of buyers.

The speculative frenzy of recent years is causing a major adjustment, and the happy talk of realtors is prolonging the process. The absence of realistic analysis about the extent of overvaluation is characteristic in an industry that sees nothing but an upward progression for values, but houses like any other asset can be overpriced.

Things are likely to get worse before they get better. The housing market will remain soft into next spring. If the inventory of unsold homes declines significantly, it will indicate frustrated buyers are removing their homes from the market.

Much latent supply, the unlisted homes of would be sellers, is likely pilling up. In fact, the inventory of unsold homes is likely much higher than the 7.3 months supply reported by the National Association of Realtors. Frustrated home owners, under no pressure to sell to relocate for new jobs or retirement, are likely holding houses off the market and waiting for conditions to improve. Those would be sellers may have to wait until 2008 or 2009 to see a robust market again.

Federal Reserve Not Likely to Boost Interest Rates

Other than energy prices, inflation has not moderated as much as Federal Reserve policy makers would like; however, the combination of falling energy, a sluggish housing market and slowing economic growth should bring inflation down soon. Inflation should fall the remainder of this year.

With both housing and automobile slowing, raising interest rates further would serve no useful purpose. The Federal Reserve should not change the interest rate policy at its meeting tomorrow or before its January meeting.

Stock Market Likely to Continue

Over the last five years, housing values have risen more than 50 percent nationally, outpacing the paychecks of buyers. Just as the stock market was ripe for adjustment after the internet frenzy of the 1990s, the housing market must endure an adjustment to compensate for the hyper enthusiasm of the past three years. Realtors, who sold homes in 2005, counseling buyers the market would continue to appreciate, may find their credibility severely damaged and repeat business from those buyers scant during the next cycle. Opportunistic appraisals will also see more scrutiny.

A moderate adjustment in the housing market is good news for the economy and the stock market. Even with modest price adjustments, households will still have enjoyed considerable increases in their wealth, and the long run outlook for consumer spending remains solid.

In recent years, Americans have been over-investing in housing, households have not saved enough in financial assets, and businesses have underinvested in commercial structures and equipment that are necessary to fuel enduring, healthy economic growth.

Following historic patterns, households will save more and invest more in the stock market, and businesses will be more inclined to spend more on plant, equipment, R&D, technology, and supply chain improvements.

Over the next year, stock prices should benefit from an adjustment in the housing market. The stock market rally should continue into the New Year, and the Dow Jones Industrial average should pierce 13,000 in 2007.