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May 12, 2005

Blame a Wet Easter Bunny
by Chad Hudson

Last week, the Labor Department reported that 274,000 jobs were created in April. This was significantly better than the 174,000 increase economists were expecting. Additionally, the past two months were revised higher by a cumulative 93,000 jobs. The weak March employment report started the wave of "soft-patch" commentary. The commentary has already shifted with economists now explaining that poor weather and the Easter shift caused the weaker economic activity. The economy was also expanded at a faster pace during the first quarter than initially reported. The trade deficit unexpectedly narrowed in March by $6 billion to $55 billion. This will boost first quarter GDP from the initial growth estimate of 3.1% to almost 4.0%. Economists also expect retail sales to increase by 0.8% in April, more than twice the pace of last month. It would also be the largest increase since December.

Retail sales as measured by the ICSC reported a 2.3% gain in same store sales for April. This was the lowest growth since November, but was impacted by an early Easter. Retail sales were best at the club stores followed by the department stores. Discount retailers posted the weakest growth. Target's sales increased only 1.3%, lower than the 2.2% increase Wall Street expected. Wal-Mart's same store sales increased only 0.1%. This was quite a drop off from the 4.8% growth posted last month and was likely due to the shift in Easter. The previous time that Easter shifted into March was in 2002 and same store sales growth was sharply lower in April compared to March. In that year, Wal-Mart's April same store sales increased only 3.2% after rising 10.7% in March. However, 0.1% growth for Wal-Mart is extremely weak. The only time same store sales have grown slower in the past ten years was in April 1996 when same store sales declined by 0.2%.

Spending rebounded through April and is running stronger in May. Several department stores reported that sales picked up each week during April. Wal-Mart said it expects its same store sales to raise 2%-4% in May, Target is a bit more optimistic forecasting sales to increase by 3%-5%. A few retailers mentioned that the number of transactions declined, but average ticket increased. This could be due to higher gas prices with consumers making less trips out, but buying more when they do go shopping. Higher gas prices would also affect lower income customers disproportionately and discount retailers posted rather weak result in April.

In February, the FDIC published a report discussing U.S. housing prices. It was updated last week using end of the year data. Across the nation, housing prices rose almost 11% on average according to the Office of Federal Housing Enterprise Oversight (OFHEO) up from the 7% growth during 2002 and 2003. This was the fastest pace since 1979 and after adjusting for inflation the 8% increase was the largest increase in 30 years. More importantly, the number of metropolitan areas that are in the midst of a housing boom jumped 72% to 55. This is twice the number just two years ago and twice the previous record of 24 in 1988. The FDIC defined a boom as a 30% real appreciation over a three year span. The report found that only 17% of the previous 63 booms ended in a bust defined as a nominal price drop of 15% over 5 years. Usually housing markets remained stagnant for several years as the economic fundamental caught up with the elevated housing prices. However, the report was quick to point out that with so many different markets experiencing a housing boom, history might be a poor guide to the current boom. It said that national factors such as the "expansion of subprime and high loan-to-value mortgage, along with the growing use of home equity lines of credit, could change the dynamics of home prices in future cycles."

Not surprising most of the boom markets were in California (21 out of 55). Most of the other areas were along the East Coast. There were 18 metropolitan areas in the Northeast and 11 in Florida. There were 24 markets that were added at the end of 2004. Of these, only 6 had experienced a housing boom before. This led the FDIC to postulate that the broadening of the housing boom could be due to a growing influence of national factors. Typically, housing markets are driven by local factors. The report said that if national factors are playing a more important role, the most import factors to examine would be the "availability, price, and terms of mortgage credit."

Using this criteria, it would appear national factors are indeed playing a much larger role in the current boom than they historically have. First, the cost of mortgage credit is near an all-time low. Usually, strong demand pushes up prices. Over the past few year, however, there has been record amount of mortgage growth, while the cost of mortgage credit has remained at or near all-time lows. Second, the terms of mortgages have been relaxed. The popularity of subprime mortgages surged in 2004 accounting or almost 20% of all originations, up from under 9% in 2003. Additionally, even as the cost of a thirty-year mortgage was near historic lows, adjustable rate mortgages accounted for almost 46% of the value of new mortgages and 36% of the number, up from 29% and 19%, respectively in 2003. Additionally, the report said that homebuyers in several of the metropolitan areas that are experiencing a boom are using ARMs more often than the national average. The report concludes that "these trends suggest that highly-leveraged borrowers are increasingly taking on interest-rate risk as they stretch to afford high-cost housing." The recent introduction of interest-only and option ARMs only compounds the situation. The last point the report addresses is the increased number of investor purchases of homes. Investors accounted for 9% of the mortgages in 2004, up from 6% in 2000 and in some of the boom markets investors comprised up to 19% of the mortgage originations.

Mortgage application surged 9.4% last week. Not only was it the strongest growth since a surge the second week of January, but it was a record as well. Refinancing also picked up along with the percent of ARMs. After declining for the past month the percent of ARMs, jumped back above 35%. It is interesting that the percent of ARMs increased while interest rates remained flat.

There are still a lot of crosscurrents in the economy and it is impossible to deduce the strength of the economy from one month of economic data. The "soft-patch" that was first thought to be the start of a slowing economy is now being dismissed as a one-month aberration caused by an earlier Easter coupled with wetter weather.

Chad Hudson
Mid-Week Analysis
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