US Housing Market's a Mess, But Don't Fight the Fed's Determination to Re-flate Asset Prices

By: Michael_Pento

It has been two years since the bursting of the housing bubble began, but we can still hear a plethora of lunacy spewed from market pundits regarding the future of this key part of the economy. After hearing that home prices would never decline, we now hear that real estate is a very small part of our economy. Last week, Mike Norman, of the Economic Contrarian Update, was part of a panel debating the future of the economy and housing and he said that inventory of unsold homes would soon fall dramatically.

His reasoning was that new home construction rates had fallen to an annual level of 1mm units and that there were 3 million more people in the country each year, leading viewers to believe that there is an insufficient supply of new homes to satisfy the population growth. As I discuss in this week's podcast , this sounds reasonable on the surface—unless you think about it for more than two seconds. Since each residence does not house one person, the math does not work in favor of Mr. Norman's contention. According to the U.S. Census bureau, there are 2.6 people per domicile.

Therefore, new home construction rates need to be about 1.15 million units annually in order to satisfy the intrinsic demand. New home construction levels are running at 1.006 unit annual level, while new home sales are running at an annual level of 604,000, which looks positive for housing on the surface. The fact is, however, that conditions remain so weak that home builders are still adding to inventories, which now stand at over a two-decade high supply of 9.6 months.  As demand became unnaturally strong during the housing bull, it will likely become unusually weak in order to correct those recent excesses.

We know that sales are down and prices are falling, the weakness in housing is not news. What is interesting to hear now from the perennial bulls, who can no longer deny the problems associated with housing, is that housing is only a small part of G.D.P.  We used to hear the mantra "as housing goes so goes the economy."  Now we hear from Brian Westbury and others that real estate is exactly 4.5% of G.D.P.  Where do they get that figure?

When you consider in aggregate the employment, durable goods, home equity extraction and wealth effect of rising real estate values, that 4.5% number jumps dramatically-some have estimated 3 times that level-and that is why the weakness in housing has caused massive disruptions in the economy and financial markets.

Just looking at equity extractions alone which we saw during the height of the bubble, consumers' took out over $800 billion from the perceived increased value of their homes. In a 13 trillion dollar economy that's 6.1% of G.D.P.! According to data compiled by none other than Allan Greenspan and Fed economist Jim Kennedy, mortgage equity withdrawal grew to 1% of the economy by the end of 2005! And if you think home equity withdrawal has disappeared due to tighter lending standards and falling values read this: as of the third quarter of 2007, such equity extractions were still running at an annual rate of $532 billion or 4% of G.D.P.! This rate will surely decline over time but the point is that housing is still a more significant part of the economy than the "official" number suggests.

The uncontained problems associated with the credit bubble, which happen to be manifested most acutely in the real estate market, will take several more quarters to work out. However, what cannot be ignored or underestimated is the Fed and Bush administration's complete abdication of responsibility to keep inflation in check, be it by massive infusions of fiat currency into the banking system or a deficit-exploding stimulus package. In their attempt to repeal the business cycle, they may be able to truncate the duration of the housing correction and economic slowdown.

However, this strategy has an undeniable consequence: inflation. As far as I'm concerned the Fed has made it clear they will take rates to zero if they must in order to re-inflate asset prices and thus, it has tacitly stated where you should be investing. My advice is: don't fight the Fed! Shorting the stock market will be a dangerous exercise and commodity-related investments should remain a focus for new money.

**NOTE: I manage an inflation-targeted portfolio on behalf of clients… use the link here to learn more

By Michael Pento
Senior Market Strategist
Delta Global Advisors, Inc.
866-772-1198
mpento@deltaga.com
www.DeltaGlobalAdvisors.com

A 15-year industry veteran whose career began as a trader on the floor of the New York Stock Exchange, Michael Pento served as a Vice President of Investments at Gunn Allen Financial before joining Delta Global. Previously, he managed individual portfolios as a Vice President for First Montauk Securities, where he focused on options management and advanced yield-enhancing strategies to increase portfolio returns. He is also a published theorist in the field of Austrian economics.

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