Rising Inventories and Price Cuts = Bottom of the Housing Recession?

By: Paul Kasriel | Wed, Dec 20, 2006
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Housing starts in November jumped 6.7% after slumping 13.7% in October. So, October marks the bottom of the housing production recession, right? Doubtful. For starters, this past November was warmer than the average of the past ten Novembers. This November, the average temperature was 45 degrees Fahrenheit. For the ten past Novembers, the average temperature was 44.08 degrees. While November was warmer than usual, perhaps prompting a bit more construction-related ground breaking than normal for November, October 2006 was cooler than average, 53.8 degree vs. 54.98 degrees. Perhaps, then, both October's and November's housing starts are overstated in opposite directions. Let's try to separate the signal from the noise by looking at the year-over-year percent change in housing starts. Chart 1 shows that the latest year-over-year reading on housing starts is minus 27.8%, the largest year-over-year decline since March 1991, when the economy was still in a recession.

Chart 1

Aside from the vagaries of the weather, the more fundamental reason why I doubt that housing production is on the upswing is that inventories of already-built new homes are rising relative total new homes for sale. This is shown in Chart 2. Completed homes for sale have jumped up to a to-date cycle-high 29.5% of total new homes for sale. Compared with previous housing recessions, this ratio of completed-to-total still is low. Perhaps one of the largest and most speculative residential real estate booms in the post-WWII era will have one of the shallowest busts.

Chart 2

Perhaps. But in case the ratio of newly-completed homes for sale relative to the total has not reached its cyclical zenith, then history suggests that single-family housing starts have not reached their cyclical nadir. As shown in Chart 3, housing starts tend to trough when newly-completed homes for sale reach a cyclical peak as a percentage of new total new homes for sale.

Chart 3

Sharply higher cancellations of new-home-purchase contracts undoubtedly are leading to the rising inventories of newly-completed homes for sale. This is prompting aggressive price incentives on the part of home builders to "move the merchandise." But with profits evaporating (see Hovnanian's latest loss report released Monday afternoon), will builders plan to build a lot of new homes soon? The permits data suggest not. Again, separating the signal from the noise, Chart 4 shows that the year-over-year trend in building permits still is down. In November, the year-over-year change hit a new cycle low of minus 32.5%. In sum, I think builders are bending over backwards to rid themselves of expensive-to-carry inventory. But once this is accomplished, it will be a warm day in January before they begin to think about rebuilding their inventories of buildings.

Chart 4



Paul Kasriel

Author: Paul Kasriel

Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

Paul Kasriel

Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.

Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.

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