Bumpy Road Toward the Fiscal Cliff

The economic news flow this week, at least through Wednesday, was slow. However, the reports we did get were excellent, with builder sentiment and housing starts far exceeding expectations. Meanwhile, existing-home sales managed to match expectations, despite the hurricane and a lack of available inventory.

The lack of economic news didn't stop the markets--they had one of their best rallies of the year on Monday as politicians struck a conciliatory tone relative to their fiscal cliff negotiations. As much as I loved the rally, the market volatility relative to each little whisper is scary, especially because volatility works in both directions--up and down. Although I'm very optimistic that a peaceful resolution will be reached, there are certainly potential bumps along the way. As a reminder, markets made wide swings during the debt ceiling negotiations in 2011. Moves of up to 10% in a relatively short period would not be surprising. So fasten your seat belts.

This week's real estate-related news was quite positive, as I note below. It now looks like home prices could be almost 5% for 2012, and housing starts could be close to 800,000. Next year prices could be up another 4% or 5%, and housing starts might just creep above the 1 million mark in 2013.

In other news, weekly shopping center sales have rebounded from their Sandy-induced lows two weeks ago with year-over-year, same-store sales growth of over 2%. On the manufacturing front, the Markit Flash PMI data showed continued improvement in the U.S. manufacturing economy. This newer metric registered its best level in five months. 

Weekly unemployment claims recovered from last week's Hurricane Sandy-induced spike to 451,000 claims, but at 410,000, the reading is still elevated relative to the 360,000 to 380,000 levels prior to the storm. If Hurricane Katrina is an indicator, claims could remain elevated for two or three more weeks. State-by-state data (only available a week after the initial report) for the prior week confirmed that the big jump in claims was almost entirely in storm-affected states. However, there was also a meaningful and unexplained increase in California claims during the storm week, which bears watching. Looking ahead, the claims data for next week might include some of the workers at several shuttered Hostess plants, keeping claims elevated for yet another week.

Now some good news. Gasoline prices have also continued to decline after this fall's unexpected spike. Gasoline prices are just about back to last year's levels, which is very good news for consumers and holiday shoppers. Gasoline prices have fallen from $3.88 in mid-September to $3.42 currently.

U.S. Position in World Energy Market Improving Dramatically
Speaking of energy, I did not have time last week to comment on the International Energy Agency report regarding the worldwide supply and demand of energy:  

The report confirms a lot of what we have been talking about for over a year, namely that U.S. oil production is way up even as demand remains under tight control. By 2020 the U.S. may well be the largest oil producer in the world, surpassing Saudi Arabia and Russia, according to the report. And with falling demand for auto fuel, the U.S. could be basically energy independent by 2035.

On the other hand, I caution that this report assumes that fracking technology doesn't encounter more environmental objections, gas prices stay high, and strict fuel efficiency standards that are already on the books are not overturned. Also, many news sources have pulled out the U.S.-centric sections of the report, but failed to mention that rising emerging-markets demand and decaying oil fields elsewhere are likely to keep energy supplies worldwide very tight and prices relatively high.

Builders Getting More Optimistic About the Housing Market
Builder Sentiment, which is compiled by the National Association of Home Builders jumped an impressive 5 points in November to 46, while most investors had expected a more modest reading of 40. The index is now at its best level since May 2006 and marks the seventh consecutive month of improvement. In comparison, just one year ago this reading was a pathetic 19. The sentiment index tends to be a good predictor of housing starts and new home sales in the months ahead.

The upturn in sentiment has been broad based, with all four regions of the country showing improvement. Even the Northeast, which was hit by the Hurricane Sandy during the survey period, showed improvement. The "current conditions" and "future expectations" parts of the three-part index showed improvement while the traffic component was unchanged from the previous month.

Existing Home Sales Holding Their Own
Existing home sales in units had a modest increase from September to October as units on an annualized basis moved from 4.7 million to 4.8 million. The November volume number was in line with expectations, though the number for September was revised modestly downward.

On a year-over-year, three-month average basis, unit sales increased 10%, continuing to show modest improvement. However, more of the market is higher-end homes this year, and there are fewer distressed properties in the mix. This means that the average selling price is up over 7%, and the dollar value of existing home transactions is up a more impressive 18% (versus the more modest 10% increase in unit volumes).

Hurricane Sandy appeared to have just a modest effect on the data. Year-over-year unit sales were down 1.7% in the Northeast while the other three regions of the country saw small increases. Fortunately, the Northeast segment is by far the smallest in terms of units, but significantly more pricey than homes in the South and Midwest. In its release, the National Association of Realtors warned that the storm is likely to depress sales in the Northeast for at least another month or two. (Homes may need to be re-inspected, some may prove to be unsalvageable and some homes on the market may need considerable repair).

Home Inventories Continue to Shrink
Perhaps the most important part of the existing home sales report on a national scale was data showing that inventory levels continue to deflate. Inventories fell 1.1% in October to 2.14 million units, representing 5.6 months of sales, its lowest level since 2006.

Keep in mind that raw inventories peaked at just over 4 million units in mid-2007, meaning that supply has basically been cut in half since the inventory peak. In the last year alone, inventories are down 23%. That explains why prices of homes have begun to turn and housing starts are up 87% from the bottom. There just is not enough supply in some markets. Below is the inventory statistic for the overall housing market, on a three-month moving average basis.

Recent Home Price Increase Puts Money in Consumers' Pockets
One other interesting sidenote in the report: The NAR calculates that the 4% or so price appreciation that homes have seen this year translates into about $760 billion of increased home equity. That would represent about 5% of GDP (though price appreciation is not included in the GDP calculation).

The other interesting thing that struck me about the number is that it is just a little greater than the new tax increases and spending cuts that would occur should we go over the fiscal cliff. Though one needs to carefully consider the source, Realtors are expecting a 5% increase in home prices next year, which would translate into another $1 trillion in consumer equity (consumers own about $20 trillion in real estate; annual GDP is about $15 trillion).

Housing Starts and Permits Moving in Tandem
A fall seasonal slump in housing starts (or real estate in general) has yet to really materialize. In fact, starts made another decent improvement in October, increasing 2.3% to 894,000 units on an annualized basis. That represents a new recovery high that is 87% above the low of 478,000 units started in early 2009. October starts could have looked even better if it weren't for Sandy. Northeast starts were off 6% month to month, despite increases in the West and Midwest.

Permit growth also remained strong and should mean that starts aren't yet due for a meaningful tumble (year-over-year growth is still up over 30%; however, permits were down sequentially 2.7% between September and October). Indeed, the consensus for 2013 housing starts is beginning to coalesce around 1 million units compared with an estimated 775,000 for 2012 and 612,000 in 2011.

Jump in Home Completions Could Mean More Housing-Related Jobs
One other interesting data point in this week's U.S. Census Bureau report was housing completions. For months, I have been complaining that housing-related employment hadn't moved nearly as much as starts. The most plausible explanation for the disconnect is that not much labor is needed at the beginning of the home construction process, but a lot of labor is needed in the final finishing stages of building a home. 

This month completions finally made a massive jump (though always subject to revision) from 674,000 annualized units to 772,000. Completions had been stuck in the 600,000-700,000 range for six months despite a more dramatic increase in starts. Maybe the U.S. will finally break through the housing employment bottleneck with this dramatic increase in completions.

Sandy Watch: Shopping Center Sales Bounce Back
I have been watching and reporting on weekly shopping center sales from the ICSC for several weeks to make sure that Hurricane Sandy didn't do more damage to the economy than initially thought (unfortunately, the damage to property estimates continue to be revised upward).

This week, the single-point, same-store sales report bounced back to a 2.5% growth rate after bottoming at 1.4%. With more Thanksgiving Day hours this year, I would expect an even bigger increase in next week's report. For now, I am not using a three-month average so I can see the storm impact just a little more clearly.

Next Week: More Real Estate Data, Upward GDP Revision, and New Personal Income Data Due
The biggest fireworks next week will be the GDP revision for the third quarter that was originally reported as an acceptable 2.0% growth. The latest read is due next Thursday, and economists are expecting a whopping revision to up 2.9%. Revision in export/import data, construction data, and retail sales will contribute to the upward revision.

Although it's hard to argue that the number won't be at least 2.5%, economists seem to be falling all over themselves to have the highest estimate. The large estimate increase is pretty well-known among economists, but I really haven't seen much talk about the massive revision in the popular media. And a 2.9% increase would be newsworthy; it would be one of the largest increases of the current recovery.

The bad news is that the fourth-quarter estimates now center on a 1.6% growth rate. I have seen estimates for as low as 1%. A lot of the pessimism centers on payback for the unusually strong third-quarter number. Also, many analysts point to a 0.7% contribution to GDP in the third quarter from the government sector due to a quick bump in defense spending that is unlikely to recur. I still think we can get closer to 2% for the fourth quarter as vastly increased auto production and smaller drawdowns in soybean inventories will offset a good deal of the hurt from falling defense spending in the fourth quarter. Right now there is not much hard data on the fourth quarter, though.

The personal income and spending report for October, which is due on Friday of next week, is probably one of the more important pieces of data (and also one of the first) relative to the fourth quarter. Based on the employment report, general expectations for income is a 0.2% increase. The employment report didn't show much of an effect from Sandy and employment was up 0.2%, hence the income expectation. However, I think some of the non-wage components, especially rent income, might move the number slightly higher than expectations. Based on a pretty glum retail sales report for October, the spending report is expected show little if any growth. On top of some small Sandy effects, post-iPhone 5 blues, restaurant competition, and falling auto sales (which probably is a Sandy effect) all will weigh on the October report. Therefore, I won't worry too much about this report, even if the results look subpar. I also believe that October may represent one of the weaker months of the fourth quarter due to the hurricane and a couple of special factors that artificially boosted the previous month (September).

Real Estate Data Probably Won't Prove Much
The FHFA and Case Shiller home price indexes are both due next week. If the  CoreLogic data received at the beginning of the month holds up, both price indexes should be up on a year-over-year basis. The Case Shiller number will probably be up 2%-3% year over year and the FHFA data should come in at 5% rates. Both of those would be an improvement over the previous month. 

Month to month, the non-seasonally adjusted headline numbers are likely to be flat or maybe move into slightly negative territory as we move into the normally slow fall season. Unfortunately, housing price data is reported with a considerable delay, and this data will be from the month of September. I suspect that when the final data is in for 2012, the Case Shiller Index will be up 4%-5% for the year, and the FHFA Index 5%-6%.

At the beginning of the year, it would have been difficult to find many investors who believed that home prices would be up more than a percent or two. Furthermore, I think economists have underestimated the positive impact of home prices on consumer attitudes. Despite all the doom and gloom, especially relative to the world economy, consumer spending has held up well.