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FEBRUARY 15, 2006

News Analysis

By Michael Englund and Rick MacDonald

Just How Shaky Is Housing?

Economists have been watching for a collapse, but it isn't here yet -- and the sector may even see a short-term uptick

Recent concerns about the housing sector -- including a Feb. 14 warning from homebuilder KB Home (KBH ) that cancellations rose and fresh orders for homes sank in early 2006 -- have put more of a focus on incoming data for the sector. That's why Wall Street will be paying close attention to the January housing-starts report, scheduled for release Feb. 16.

We at Action Economics expect housing starts to rebound 6.6%, to a 2.06 million-unit annual pace in January, above economists' median forecast of a 2.025 million rate. Weather appeared to be a big factor holding back construction activity in December. But given the favorable swing in the weather in January, alongside the strong January employment report and the robust weather-driven surge reported in retail sales for the month, we expect a weather-induced lift for housing starts as well.

Post-hurricane rebuilding should also provide a boost to activity over the next few quarters. But recent trends in the National Association of Home Builders survey and the MBA weekly mortgage applications survey suggest some downside risk to the January forecast. The aggregate construction hours worked data from the January employment report, released Feb. 3, supports a rebound on the month.

LONG WAIT.  The data should be consistent with real residential investment growth at a healthy 6% rate in the first quarter. We expect growth in the housing sector to moderate back toward the 3% to 4% trend-growth in the economy by the end of 2006.

Yet most market economists are entering 2006 (the way they did 2005, and 2004...and 2003...and 2002) expecting a drop in housing activity for the year, given the enormous "overshoot" of activity through the recession. Despite the ongoing pessimism, the sector keeps setting new highs.

When will the long awaited slowdown finally materialize? The first signal may be the weak round of data for December housing starts, construction, and sales. But winter data tend to be volatile, and December weather was particularly harsh, which makes this round of lean figures suspect. The positive effects of the weather rebound in January is apparently sending a powerful ripple through the U.S. data, which could abort any negative market spin from the lean December housing figures.

MORTGAGE WATCH.  Anecdotal evidence from the housing sector remains notably mixed, as industry references to a "slowdown" are fairly meaningless given the historic gains posted in many important housing measures last year. It still appears that forecasts of any significant slowing are as much conjecture as fact, given the usual pattern of seasonal-related volatility in the winter months.

Also worth watching are mortgage rates. Overall, they're still at very attractive levels on a historical basis. But over the last three months, they have moved higher and are finally reversing their surprisingly persistent pattern of year-over-year declines, with the largest increases seen in adjustable-rate mortgages.

Specifically, mortgage rates have increased across the spectrum by roughly 50 basis points over the last three months. Though small on a historic basis, this run-up likely explains some of the recent softness in housing sector activity.

SOUND SECTOR.  Meanwhile, permit data have remained strong, although they have moved lower in recent months -- suggesting the possibility of a more throttled pace of construction in 2006.

Overall, recent indicators point to a moderating, but not collapsing, housing market. We still believe the slowing we expect in 2006 will be gradual, and consistent with a solid housing sector overall.