For those new to trading, new to me, or my methodology, I think the following ground rules will help...
Housing’s Weakness May Sink Economy
05/15/2007 12:00 am EST
A. Gary Shilling, editor of A. Gary Shilling's Insight, thinks many people are underestimating the damage the housing decline will have on the economy.
The hope that robust pay and job gains will persist and overcome housing weakness is held by many bulls, but is strongly opposed by history and unfolding events.
Overall employment is still strong, but that's normal at this stage of the business cycle. As in the past, the weakness that will end this expansion is starting in the housing sector, not in the general job market. Indeed, announced layoffs in the real estate, construction, and mortgage industries leaped 346% in the first quarter, and many more are following as mortgage lenders bite the dust and homebuilders continue to retrench.
These job cuts curtail consumer sentiment and spending, especially since construction jobs pay so well and have increased so much during the housing bubble. The result is excess inventories throughout the economy since business does not cut production immediately in the face of weak sales. But surplus inventories lead to widespread production cuts, layoffs, consumer spending weakness, and the onset of recession.
In the past seven recessions, housing starts turned down well before the peak of business while construction employment normally led the economic cycle and fell well before the decline in total payroll employment.
History, then, says that the current strength in overall employment will fade in coming quarters as subprime mortgage woes spread and drag the economy into recession. We're convinced, then, that housing weakness will sink overall employment, as usual. That's already happening in a number of metropolitan areas where decelerating house prices and rising foreclosure rates are depressing overall employment growth.
Consumers are becoming aware, if stockholders aren't, of the likely spreading of subprime woes. Their sentiment is weakening and it normally turns down ahead of recessions and unemployment. Consumer spending, now a commanding 70% of GDP, is vulnerable with the collapse in homebuilder sentiment and the jump in mortgage credit tightening.
And the 25% drop in house prices we foresee will destroy the appreciation that homeowners have relied on in lieu of income growth to support rapid spending advances. Indeed, in March personal spending rose only 0.3% from February, and far less than the 0.7% rise in after-tax income. At the same time, the slowing economy is reflected in UPS's deceleration in package deliveries and declining railroad shipments.
Fears of falling house values are curtailing the purchases of boats and other discretionary items that normally require financing. Furthermore, the US housing weakness is already spreading abroad. Many Latin Americans who work in US construction send funds home that are important sources of income for their families. An estimated $50 billion in total moves south annually, and Mexico is being especially hard hit.
If US house prices and sales suddenly reverse and jump skyward, the soft economic landing the consensus hopes for is possible. Otherwise, look for subprime mortgage woes to spread, an American recession to commence later this year and to extend globally in 2008.
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