No Signs of Housing Strength

 | Nov 15, 2012 | 4:30 PM EST
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On Wednesday, I wrote about the dichotomy between the positive stock performance of companies in the housing space and the negative performance of mortgages on the books of the money centers this year. I concluded that this can't continue, and either signs of a rebound in housing and mortgage performance must be seen immediately or these stocks would begin to decline dramatically.

I don't think housing is going to show signs of strengthening soon, dramatic or otherwise.

Housing cycles have well defined characteristics that repeat historically. Succinctly, the pattern is that price appreciation starts with entry-level homes and then moves up to mid- and finally high-end homes.  The peak valuation of high-end homes coincides with maximum consumer optimism.  Values then begin to decline in the entry-level market with that process then extending to mid- and high-end homes. The bottom of the market occurs when high-end home values have declined commensurate with the decline in entry-level homes and this coincides with maximum consumer pessimism.

The ongoing consolidation of home values in the high-end market has so far not declined commensurately with the declines experienced by entry- and mid-level home values.  The  sentiment concerning housing also has not reached a correspondingly negative level to the positive level that occurred at the top of the market in 2006.

In general, just as sentiment at the top of the market was indicated by the consensus belief that housing values never fall, the bottom should be indicated by the meme that housing never appreciates. Both are irrational, but once a bubble peak has been identified, a corresponding reduction in values and sentiment equal to it in breadth and depth should occur. So far, that hasn't happened. But based on historical precedence, it still should.

The stock performance of companies in the housing space and the traders and investors driving them this year is most probably more indicative of an echo boom or mania than of a secular resurgence in home values and transactions. The Federal Reserve is certainly aware of this, as indicated by the announcement of intentions to purchase $40 billion of mortgage-backed securities monthly this past September. (Chairman Ben Bernanke addressed this issue again today in a speech he gave at the Operation HOPE Global Financial Dignity Summit in Atlanta, Ga., titled "Challenges in Housing and Mortgage Markets.")

Beyond the historical precedence for housing cycles, though, and the ongoing issues of non-performing loans, there are deep structural and demographic issues that will provide a drag on the housing sector for the next generation and are already beginning to be felt.

Tighter lending standards and higher levels of personal debt by the two generations behind the baby boomers is making access to mortgages more difficult.  The engine of the housing market is the first-time homebuyer. Their buying is one of the principal drivers of overall valuations and provides the ability for move up buyers and for the sale of second and vacation homes.

It is more likely than not that consolidation in the housing sector will be evident soon with national average values declining by another 10% nominally and high-end values by 25%.

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