Sunday, March 19, 2006

All Eyes on Midwest & South

Is the housing sector becoming less sturdy? The final U.S. house-price data for the fourth quarter, released earlier this month, confirm that a robust uptrend was intact through December -- despite widespread perceptions of declines. But housing-sector data releases for the first quarter are telling a different story.

Action Economics still expect the cooling of the red-hot housing sector to be gradual, though the January sales reports, and a sustained downtrend in the Mortgage Bankers' Assn. purchase index, present some red flags for this vital segment of the economy.

URBAN-MARKET COOLING. The home-price data from the Office of Federal Housing Enterprise Oversight (OFHEO), which reflect a carefully constructed index based on "repeat sale" information, revealed a powerful 11.9% rate of price increase in the fourth quarter that was not significantly different than the 13% growth rate for prices in 2005 overall. The declines in widely watched monthly data on median home prices from the new- and existing-home sales reports -- which are notably not seasonally adjusted -- reflected nothing more than the usual seasonal weakness in the fourth quarter each year.

But the double-digit gains may be a thing of the past: We expect growth in home prices to pull back to 5% in 2006. The moderation should be led by a pause in price gains in the hot urban markets that saw big upward moves in 2005, with weakness that may be front-loaded in 2006, given housing market jitters in the first quarter. But steady price appreciation is likely in the rest of the country -- and that should drive ongoing price gains on a seasonally adjusted basis.

We assume that the 5% price appreciation in the OFHEO data for 2006 will correspond to more restrained 3% to 4% growth in the more volatile existing home-price measure, with growth in the second and third quarters that sharply outpaces the first- and fourth-quarter rates due to normal seasonal patterns.

REGION BY REGION. On a regional basis, price gains in the Midwest and South -- which account for a whopping 79% of the national new-home market -- have posted persistent and sustainable price gains through this expansion. These are likely to largely continue through 2006.

The slowdown for the year will mostly reflect moderating price growth in the Northeast and West. The latter two regional markets have each posted price gains that are not that unusual relative to each of their separate prior cyclical behaviors. But the recent gains are atypical in that they are both occurring at the same time.

This propensity for coinciding big price gains in concentrated urban markets is largely a global, rather than U.S., phenomenon. It's the expected coinciding moderation in both regions that runs the risk of having a national impact -- the separate corrections in the West in the 1980s and early 1990s, and the Northeast in the late 1980s, had no measurable effect on the rest of the economy as a whole.

JANUARY SURPRISES. The regional dichotomy in price movements is accompanied by a price dichotomy in new- vs. existing-home sales data as well. Surging new-home prices relative to existing homes in 2004 was followed by the reverse pattern in 2005. Much of the recent divergence has been consistently revised away in prior months through ongoing upward revisions in the new-home price data. As such, the persistent recent gap should be taken with a grain of salt.

The sales statistics from the new- and existing-home sales reports also remained robust through the end of last year, with the usual volatility. Both these reports revealed downside surprises in January that may signal that we're finally seeing the culminating effects of anecdotal evidence from industry sources through the third and fourth quarters of reduced pricing power, even if actual prices kept marching higher.

Major housing aggregates lost some upside momentum in the second half of 2005, and these reports are showing moderation in the first month of 2006. Despite the swing toward notably warmer weather in January from the bleak December, we got little of the bounce we thought would materialize in the reported figures. After pushing against capacity constraints through much of this expansion, the housing sector appears to finally be showing a little leeway as we enter the first quarter.

VOLATILE DATA. Housing-starts figures suggest that the recent moderation in activity largely reflected a big negative weather hit in the West in December, followed by lean figures elsewhere in January despite warm weather conditions. Activity remains remarkably robust in the South, which is where nearly half of the national housing market is located, and persistent strength here will limit any losses in the national housing statistics in 2006.

A bounce in the February housing data could reverse conclusions drawn from the January data, though both the pending home-sales data and MBA purchase data suggest a weak round of February figures as well.

The MBA new-purchase data may provide a more ominous reading on prospects for the February housing data. There, we've seen a sharp downtrend through the most recent week ending Mar. 3. Yet, these data are volatile, and have shown a bout of weakness at some point in the annual seasonal "lull" in each year of this expansion. As with the pending home-sales figures, the numbers provide just one indication of downside risk in the February numbers. With increasing jitters about the health of the housing sector, these data will be closely watched as we approach the seasonally critical second-quarter period.

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