In the prediction game of deciding if the economy’s downshift will be soft or hard, real estate figures prominently as a clue of substance. We say that based on the knowledge that the bull market in housing in the 21st century has been spectacularly robust in elevating consumer spending. If the real estate boom turns from boom to bust, the ensuing fallout will have no less an impact on the economy, albeit in reverse.
It may be too early to forecast what the housing slowdown will bring, or extract, but there’s no doubt that a slowdown is underway and the change is conspicuous. As evidence, one need look only at a graph of the percentage change in revolving home equity loans to realize that the tide has turned in a material way. Take a look at the chart below, which comes courtesy of yesterday’s research report from Northern Trust’s Asha Bangalore. Notice anything dramatic in the chart?
Revolving home equity loans are, of course, just one piece of a very large and complex real estate puzzle. As such, the massive industry of residential real estate turns on more than just home equity loans. That said, it’s hard to imagine that the collapse in home equity loans of late, relative to its year-earlier level, doesn’t reflect a wider trend underway in housing, namely, a correction. In fact, as Bill Conerly’s Businomics Blog pointed out last week, the evidence is mounting that the pullback in housing is something more than a minor hiccup.
Meanwhile, the connection of home equity loans to the broader economy is clear, as Bangalore reminds in yesterday’s research: “Households tapped into home equity to the tune of about $600 billion in 2005 to support their expenditures.” And those expenditures have been instrumental in raising GDP in recent years. Indeed, consumer spending overall comprised 70% of GDP in this year’s second quarter, according to numbers from the Bureau of Economic Analysis.
To be sure, $600 billion of home equity loans is just 6.5% of the seasonally adjusted annualized $9.23 trillion in personal consumption expenditures (PCE) in the second quarter. But when you consider that PCE in this year’s second quarter rose by just $149 billion over the first quarter, it’s clear that that marginal impact of $600 billion in home equity loans on economic growth is potentially huge.
The trouble arises from the realization that last year’s $600 billion of home equity loans will be something less this year. The growth rate of home equity loans this year is decidedly negative, Bangalore reports. “For the tenth straight week, home equity loans dropped from a year ago,” the Northern Trust economist writes, an observation illustrated in the chart above.
It’s no surprise to the home building industry that a correction is underway in the housing business. Looking at Morningstar’s 129 equity industry benchmarks, home building’s performance this year is ranked 128, which translates into 32% loss in 2006 through yesterday. For some stocks in the industry, the damage is far worse. Shares of Comstock Homebuilding Companies (Nasdaq: CHCI), for instance, have shed nearly 70% so far this year.
Although shareholders of home building stocks are all too aware of what’s unfolding in their marketplace, equity investors overall are unmoved by the bear market in residential real estate companies. The S&P 500 is comfortably in the black thus far in 2006, posting a tidy total return of 5.3% through August 21.
Considering the contrast between equities generally and real estate particularly, one has to ask if one side has underestimated the threat, or if the other has simply overreacted. Everyone has their own theory, and an axe to grind. But the definitive answer will arrive soon. In the meantime, we can only wait for the statistical evidence that will inform us if Joe Sixpack can maintain his penchant for spending while a key pillar of the boom in conspicuous consumption crumbles. We’re all data dependent now.