The U.S. economy is clearly in retreat with fourth quarter GDP contracting by 6.2 percent, the largest quarterly contraction in 26 years. A deep recession, tight credit conditions and a broken banking system are making it difficult for the real estate market to recover. Both businesses and consumers face enormous challenges as aggregate spending retrenches and equity values and home values continue to fall.
Economic activity this quarter is expected to remain dire according to recent economic reports. Home sales have dropped and job losses continue to mount. Businesses have cut back markedly on investment in plant and equipment, fueling additional job losses and less consumer spending.
The $787 billion stimulus package has yet to hit the streets and we can only hope that it has some positive impact on economic activity. The banking system has again hit a snag as the government contemplates further investment and control in Citigroup. Problem asset quality appears to be deteriorating among many banks as the economy weakens.
Government programs to aid the housing sector are more on paper than reality. It will take time for the details to be worked out and the programs such as foreclosure mitigation to be implemented. Federal Reserve efforts in the mortgage-backed securities markets have had some meaningful impact but more is needed to provide needed liquidity.
Perhaps the most disappointing news was in the housing sector when both existing home sales and new home sales in January plummeted to new cyclical lows despite historically low mortgage rates. Demand for homes has clearly dropped another notch as households face challenging economic times. Tight underwriting and uncertainty about the economic future are keeping households on the sidelines and away from the home and automobile purchase marketplace.
Recovery in our nation’s housing sector has taken a step backward. Most economic and housing measures and indicators suggest continued weakness in the housing markets during the first half of this year. We believe the Case Shiller twenty city home price index will drop another 8 to 12 percent before home prices begin to stabilize. Inventories remain excessive and residential construction activity is at a standstill.
This past week’s economic reports were as expected—disappointing. Real GDP fell 6.2 percent at an annualized rate in the fourth quarter. This is the largest contraction in economic activity since 1982. Consumer spending was down 4.2 percent, while fixed investment was down 21 percent. The only component that expanded in the fourth quarter was government spending at 1.6 percent. The fall in consumer spending was the largest quarterly decline since the 1970s. Similarly, businesses are cutting back dramatically on investment in equipment, plant and software. It is now clear that the U.S. economy is experiencing the sharpest recession since the Great Depression. And it is also clear that the contraction will continue over the next few quarters.
The University of Michigan consumer sentiment index dropped near its cyclical low in February, reflecting consumer fears about the recession. The largest drop was in the expectations component which fell to 50.5 in February from 57.8. Durable goods orders fell 5.2 percent in January, marking the sixth consecutive monthly decline. There was also a 3.7 decline in shipments in January, reflecting a struggling manufacturing sector. Jobless claims for the week ending February 21 increased 36,000 to 667,000. This was disappointing news for the labor markets. Businesses are laying off workers at an accelerating pace. This labor report portends unfavorably for the nation’s unemployment rate, which we expect to climb near 10 percent before the recession stabilizes.
The nation’s housing sector took it on the chin this past week as home sales in January fell to new cyclical lows. Existing home sales fell by 5.3 percent in January to 4.49 million annualized units. The months’ supply registered 9.6, while the median home price fell 14.8 percent year over year. Historically low mortgage rates are having little influence on household decisions to purchase homes. Most households have apparently decided not to participate in home buying due to the uncertainty of the economy and the likelihood that home values will fall further. In addition, a large percentage of existing home sales continues to be foreclosures which are selling at discount prices.
New home sales continued their descent in January dropping 10.2 percent to 310,000 annualized units. The median sales price decreased 9.9 percent from December. The months’ supply of new homes reached a new high at 13.3. Similar to the existing home market, the new home market is weak because of dismal economic conditions. In addition, the new home market is getting hurt by the flood of foreclosure sales competing for home buyers at deep discount prices.
The Case-Shiller monthly home price index for 20 cities fell 18.5 percent from a year ago in December. The index has now fallen 24 consecutive months. Excess housing supply and weak demand conditions continue to exert downward pressure on home values. We expect this index to post declines throughout this year. Mortgage applications to purchase homes fell 2.6 percent to 250.5 for the week ending February 20, while the refi index fell 19.1 percent to 3,618.0. The purchase index is hovering near a cyclical low and does not portend favorably for future home sales. Historically low mortgage rates are not bringing households to market due to a struggling economy and tight credit conditions.