Tuesday’s update on existing home sales confirmed what Monday’s new home sales only hinted at: the real estate market’s cooling.
May’s tally of existing home sales (by far the larger data sample compared with new homes) dropped 1.2%, the National Association of Realtors reported yesterday. That’s the second monthly decline in a row, while May’s sales are off 6.6% from the year-earlier figure.
The Northeast U.S., the leading property market in the country, suffered the biggest hit in May, with sales of existing homes falling by 4.2%. Meanwhile, the West through last month endured the worst year-over-year comparisons, posting a -13.5% stumble in sales as of May.
This, dear readers, is what a cooling housing market looks like. And given the outlook for interest rates, which is still up, expect more of the same from the world of housing.
Additional clues of a slowdown in the formerly red-hot property market can be found in the stocks of home builders. Indeed, among the 129 equity industries tracked by Morningstar, home building is dead last in performance terms so far this year through yesterday, posting a -28.5% collapse. By comparison, the S&P 500 is up fractionally so far this year with a 17-basis point return through last night.
Retreating prices among home builders comes as no surprise for those who watch these companies. Indeed, Lennar Corp., a leading publicly traded home builder, became the latest in the industry to shave its outlook for 2006 earnings. Although the company reported a better-than-expected quarterly profit, investors weren’t satisfied, and proceeded to sell the shares by three percent on the day by the close of Tuesday’s trading. Forward-looking perspectives are all that matter these days in real estate, and the morrow continues to give reason for caution.
A Morgan Stanley research report issued on Monday reflected the gloom about real estate that’s found traction on Wall Street of late. “Given the deterioration in fundamentals across all of Lennar’s markets during the second quarter, combined with management’s focus on driving volumes to the detriment of margins, we believe guidance could face further downward revisions,” Morgan Stanley wrote, via MSN Money. “We believe Lennar faces near-term operational challenges that are likely to result in further negative earnings revisions and the underperformance of the stock.”
If the cycle has turned, the Fed should be happy. Nudging real estate’s momentum to bearish, if only slightly, from bullish was the game plan all along, right? Consumer spending, fueled by soaring home equity values, needed to be taken down a notch in order to take the edge off inflationary momentum that has spooked the central bank in recent months. As such, one might wonder if now there’s enough restraint injected into the system to put the interest rate hikes on hold–after tomorrow, that is.
But before we get ahead of ourselves, let’s point out that tomorrow seems fated for another 25-basis-point hike, elevating Fed funds to 5.25% once the dust clears at today-and-tomorrow’s FOMC meeting. Fed fund futures have been steadfast in predicting no less over the last two week.
But the financial crowd is getting restless as it looks out into the summer. On the leading edge of anxious money managers is Ed Yardeni, chief investment strategist at Oak Associates and co-manager of the Oak Fund. “Fed officials are unnecessarily, and perhaps dangerously, destabilizing global capital markets by exaggerating the inflation problem in the U.S.,” he and Steven Einhorn of the hedge fund shop Omega Advisors wrote in a research note this morning. “They are also confusing investors about how they are monitoring and assessing the extent of the problem and how they are likely to respond to it.”
On the second complaint, we couldn’t agree more. As for the first, we’re not so sure–at least not yet. It’s a given that the Fed will err in its monetary policy. That’s the nature of systems devised and managed by humans fated to make forward-looking decisions with lagging data points. Witness the deflation scare of a few years back. The Fed decided to err on the side of fighting deflation. As it turned out, that fear was misplaced. In any case, the result in the here and now is one of mopping up the resulting excess liquidity, which has a tendency to bite back long after its initial arrival.
The Fed now faces the thankless task of deciding how and when to err, a game otherwise known as monetary policy. For our money (no pun intended), erring on the side of caution still makes sense, if only slightly. As Fed Chairman Bernanke observed a few years back, injecting liquidity into the economy takes about as much time and effort as falling out of bed. The reverse action, by contrast, is usually a slow and often painful process, and one that’s further complicated if the central bank tries to live up to its other primary mandate of maximizing employment.
If the Fed is proven to be wrong in erring on the side of nipping any inflationary momentum in the bud, it can always reverse course in a heartbeat. On the other hand, if it’s too dovish, and allows inflation to gain a stronger foothold, correcting for that error could take a generation, as the late G. William Miller (Paul Volcker’s predecessor as Fed chief) learned the hard way.