Financial Fundamentals

Is Housing About to Sink Our Slowing Economy?

By Thomas K. Brueckner, Strategic Asset Conservation

A few weeks ago, Americans learned that first-quarter U.S. economic growth (GDP) was revised downward to 1.8 percent from the massively overestimated 2.5 percent annual pace. Then we learned that forecasters have reduced their target year-end GDP expectations downward yet again, from 1.4 percent to 1.1 percent. With manufacturing slowing worldwide, much of Europe in a prolonged recession, and federal cutbacks due to budget constraints, the prospects for a sustainable recovery are dimming before our eyes.

Then there’s housing, which economists tell us was responsible for more than 69 percent of economic output (GDP) in the first quarter of this year. With the recovery in real estate just having reached consistency and—some are hoping—sustainability, mortgage rates on a 30-year fixed loan have jumped an astonishing 1.2 percent since May, to nearly 4.6 percent today. While still low by historical standards, this is an enormous blow to home builders nationwide, and the dramatic 25 percent average reduction in the share prices of their stocks is proof of this, consistent with the new home construction contract cancellation rate, now at 22 percent nationally.

Think about a typical couple buying a new-construction home with a 20 percent deposit. For every 1 percent increase in interest rates on a 30-year fixed mortgage, their total interest costs over the life of the loan increase nearly 35 percent. When one factors in the typical listing price increases of 11 percent in a year and 21 percent over two years, that couple is paying over 50 percent more for the same home now than they would have paid in 2011! In dollar terms, a couple who was pre-approved for the financing of a new-construction home at contract signing, may no longer qualify when that home is completed and the builder is ready to close.

What does all this mean for the stock market? Opinions differ widely, but consider the macro-economic obstacles to a continuation of the current rally. Historically, legitimate bull market rallies last 3.7 years from trough to peak. The present rally is now 4.4 years old and we are barely crawling forward economically speaking, aided enormously by the Federal Reserve’s accommodative bond purchases, effectively guaranteeing a positive outcome in the markets whether or not the economic data justifies that confidence. Logic dictates that the further out onto a branch one crawls, the more likely that limb is to let you down—slowly or harshly. The market’s recent “taper tantrum” is proof that Bernanke’s cotton candy offerings may keep the kids energized for a time, but are far from what constitutes a sustainable balanced diet, i.e., free markets independent of government manipulation. Everyone knows that eventually the market’s nutritional balance will have to be restored, even as all of us have enjoyed the sugar high of the last five years.

Many are calling for a volatile and rough summer, saying that a 10 percent to 20 percent sell-off in the S&P 500 would not be unrealistic and is even warranted. Markets hate uncertainty, the very thing that will persist until we get more data in August and September telling us the impact that higher rates have had and are having on the economy. It’s not likely to be pretty, and there’s already too little room for error. Since official recessions are defined as two consecutive quarters of negative economic growth, it may be early January when we finally find out—after the usual downward revisions of course—that the U.S. economy, like so much of the rest of the world, has been in recession since the end of June 2013. Even absent the R-word, “soft landings,” what optimists call non-existent growth amid turmoil, can make for rough sledding too.

Don’t say we didn’t warn you.

Thomas K. Brueckner, CLTC, is president/CEO of Strategic Asset Conservation in Scottsdale, a conservative wealth management firm with clients in 18 states and six countries. He is a 2011 Advisor of the Year national finalist, a radio talk show host, and a mentor to other advisors nationally. He may be reached for comment at go2knight.com.