The debate over the fate of the U.S. housing market rages on and no one can be sure how it will play out but here's a three-pronged argument supporting a bubble bursting theory.
Supply and Demand
It's a simple case of supply and demand. Housing starts, annualized, have exceeded two million units for six consecutive months which has only happened three other times in modern history. Household formation last year was much lower than it was during any of the three other periods. The result is an oversupply in housing that is beginning to be evident. The backlog of unsold new homes has moved to a 4.9 month supply, the highest since December of 1996.
Yield Curve Inversion
The Federal Reserve has raised rates eleven times in sixteen months and has given little indication of letting up. Over the last three decades there have been eight other tightening periods and the yield curve inverted five of those times as a result of the Fed "overshooting neutral". The U.S. economy slipped into recession as a result of all five of those Fed-induced inversions.
Energy prices have more than doubled in the last year and, with more than half of American homes heated by natural gas, an impact on consumer discretionary spending is a given. Households have spent $100 billion more on energy this year than last and, while energy prices have eased a bit, we're likely to hit $150 billion by year-end. Add to that the impact of higher short-term interest rates and we can subtract 2-3% from consumer spending. Merry Christmas.
Seem dismal? Later we'll take a look at the arguments for a soft landing.
*Data from the October 27, 2005 ML RIC Report