An abnormal recovery
Things in the U.S. economy are moving in the right direction, but the pace will be slow, frustrating and very likely to disappoint investors betting on a rip roaring old-fashioned recovery.
News that the Standard & Poor’s Case-Shiller 20 City house price index rose for the first time in almost three years in the three months to May was greeted with much rejoicing.
The Case-Shiller data is important and encouraging but not nearly as positive as it looks at first glance.
For one thing, house prices are supposed to rise in the spring; when looked at on a more meaningful seasonally adjusted basis prices are still falling, though at a slower rate than before.
For another, the relative improvement coincides with foreclosure moratoriums which are delaying but not eliminating the flood of repossessed houses. One way or another these houses will need to clear the market and be a continued source of downward price pressure.
Rather than a recovery we are probably facing an extended slow descent in house prices. Compared to how things looked in February this is good news.
Inventories of unsold houses are declining, though they are still unusually high, and housing starts actually rose in June, though again from historically very low levels.
All in, it looks like a tentative recovery in housing activity, which will feel very good indeed after the past two years.
In combination with a bit of inventory restocking, after all there is some final demand in the economy, you might even call it a recovery.
But rather than springing out of bed and hurtling back to work, the U.S. economy will be like a recovering swine flu victim with little energy and very susceptible to a relapse.
“The normal cyclical dynamic in which housing, consumer durable goods purchases, and investment spending rebound in response to monetary easing is unlikely to be as powerful in this episode as during a typical economic recovery,” New York Federal Reserve President William Dudley said in a speech on Wednesday.
“There are a number of factors which suggest that the pace of recovery will be considerably slower than usual,” he said.
America is still “long” housing, its just that too many of the houses are not in the right places and too many are owned by people who’d be better off renting.
We’ve seen the homeowner vacancy rate decline, but the rental vacancy rate rise to record highs. Even if we believed that the price adjustment was over, it would be hard to underwrite a strong economic rebound on the back of housing in the current circumstances.
BALANCE SHEETS REPAIRED, CONSUMPTION IMPAIRED
The key to any recovery is consumption, which at 70 percent of the U.S economy may well be at a generational high.
Even if house prices don’t fall very far from here, they, along with stock prices, are down enough to have dealt a very serious blow to the average household’s balance sheet. Quite sensibly, if a bit surprisingly, people are attempting to fill that hole by saving.
According to U.S. Commerce Department data the savings rate rose to 6.9 percent in May, the highest since the end of 1993 and up from just over zero in early 2008. Who’s to say too that Americans don’t continue to increase their savings from here, perhaps back up to 8.0 percent or more.
Unemployment is rising and will take some time to fall and there is a growing realization that given growing life expectancy people’s pensions are woefully underfunded.
Income growth is not going to rescue consumption either. The New York Fed’s Dudley pointed out that despite cuts in hours worked and lousy wage gains, incomes in the first half of the year were boosted by a number of one-time factors, such as falling energy prices and a one-off payment to Social Security recipients.
A higher savings rate and poor income growth add up to a really profound check on consumption spending, something that will make earnings growth for many companies difficult despite savage cost cutting.
I’d bet too that income growth recovers long before the savings rate falls. Business plans or investments strategies based on growing consumption in the U.S. are going to be losing ones for quite some time.
And of course there is commercial real estate, which is not only the single biggest landmine for banks but will be a source of further outright contraction as current projects are completed and developers, businesses and their banks shorten their sails.
Construction, once begun is carried through but who will be breaking ground on new projects?
None of this is necessarily bad, and again, is actually pretty good compared to where we were just a few short months ago. But a world in which Americans save and pay down debt and where banks lend cautiously while rebuilding balance sheets may not be one where current stock market values are validated.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)