Kristina Hooper, CFP®, CIMA® is head of portfolio strategies for Allianz Global Investors Distributors LLC. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
The U.S. economy is shrinking faster than anticipated, suggesting this year’s stock-market rally could be in jeopardy. But bright spots like the nascent housing recovery shouldn’t be overlooked.
The government revised downward second-quarter gross domestic product to 1.3% from 1.7% as inventory investment, consumer spending and exports grew at a slower rate. The drought in the Midwest played a pivotal role in undermining GDP, causing a $12 billion hit to crop output and a significant restatement of farm inventories.
Durable goods orders sank 13.2% in August to a seasonally adjusted $198.49 billion—well below expectations. In particular, commercial-aircraft purchases tumbled and demand for other items faltered—the latest signs of a weakening manufacturing sector. Although today’s ISM report showed expansion after three months of contraction.
But while investor sentiment turned negative, consumer sentiment was surprisingly strong. September consumer confidence clocked in at 70.3, well above expectations. The latest reading showed improvement in consumers' view of current economic conditions, especially the job market. And they are more positive about the short-term outlook for some key factors: business conditions, the employment situation and their own financial situation. Some economists and strategists attribute the rise in consumer sentiment to two key developments: the recent stock-market rally and a turnaround in the weak housing market.
This makes sense since, for most consumers, the two biggest assets on their personal balance sheets are their 401(k) plans and their homes. While stocks gave up ground last week, they have posted a solid third-quarter and a strong, year-to-date return of 16.4% for the S&P 500 through Sept. 28, enlarging consumers’ 401(k) balances and, in turn, boosting sentiment.
But perhaps even more powerful is the turnaround we’ve seen in housing, which also seems to have buoyed sentiment. Although new-home sales in August slightly disappointed and lost some ground relative to July, year-over-year home sales are up almost 28%. In addition, the median price for new homes in August is up 17% from a year ago, its highest level since December 2004. Adding to optimism on housing is a relatively low inventory for new single-family homes, which should help sustain the housing recovery. Keep in mind that new home inventories stayed below 5.0 for much of the housing boom from the mid-1990s through the mid-2000s.
The improvement in pricing we’re seeing is partly due to this tighter supply. Interestingly, this low inventory level could also enable residential construction to continue contributing to real GDP growth in the second half of the year.
Stronger new home sales are clearly impacting the optimism of home builders, which rose in September for the fifth straight month and are now at its highest level in more than six years. The National Association of Home Builders/Wells Fargo housing market index moved up three points to a reading of 40—its highest level since June 2006. While the index is nowhere near 50, which indicates expansion, it has made significant strides since the housing crisis began. It was at a low of 8 during the recession.
But the encouraging news in housing was not limited to new homes. Total existing-home sales rose 7.8% in August, to 4.82 million homes (annualized) from 4.47 million homes in July. This is 9.3% higher than the 4.41 million we saw in August 2011. The national median existing-home price (for all housing types) was $187,400 in August, a 9.5 % increase from a year ago. The last time there were six back-to-back monthly price increases from a year earlier was from December 2005 to May 2006.
Existing-home prices are being helped by a reduction in the number of foreclosed and short-sale houses on the market. Indeed, distressed homes fell to 22% of all home sales in August, down from 24% in July and 31% in August 2011. Existing residential home inventory has also contracted: we are currently at a 6.1-month supply, down from a 6.4-month supply in July. Listed inventory is 18.2% below a year ago when there was an 8.2-month supply.
Despite the positive impact this good news has had on consumer sentiment, investors remain pessimistic. Concerns over third-quarter earnings, the fiscal cliff, the euro zone, China’s slowdown and myriad other uncertainties are likely to continue to weigh on investors.
While housing only represents a portion of the economy, its psychological effect may be even more important. Housing contributes to GDP through private residential investment and consumption spending on housing services. Historically, residential investment has averaged roughly 5% of GDP while housing services averages between 12% and 13%, for a combined 17% to 18% of GDP. But if a recovery in housing can continue, it may provide a big boost to consumer confidence.
Intuitively, the market feeds off confidence. And the economy benefits when that confidence is expressed through higher spending. If 401(k) accounts and home values continue to grow, then consumers will have better balance sheets. That translates into more purchasing power and an increasing likelihood to spend. Let’s hope near-term volatility doesn’t prove to be a confidence killer.
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