Thursday, December 8, 2011

The good, the bad, and the ugly of today's US housing market

In a recent post on the US housing market we discussed the persistent weakness in the market and the divergence of the "non-distressed" sector. Let's briefly examine the factors both negative and positive impacting the housing market pricing today.

First the positives

1. Mortgage rates.
The chart below shows the JPMorgan MBS total return index. The index is close to the highs, indicating continuing strong demand for agency securities.

JPMorgan MBS total return index (Bloomberg)

This means that the US government, who is financing the bulk of US mortgages, is able to fund these loans quite inexpensively. Therefore mortgage rates continue to move down and in fact now quoted at near record lows (just over 4% on a 30-year conforming mortgage).

30 Year Conforming rate. Source: BanxQuote, Bloomberg

2. Relative valuation
Based on the long-term trend in the housing market, we significantly overshot "fair value" and then potentially "over-corrected". The next chart from Capital Economics shows where we are relative to the trend.

Source: Thomson Datastream and Capital economics

Similarly relative value can be estimated based on two metrics: Disposable income and rent levels. Both of these measures indicate that housing "affordability" is in fact at levels that would make US homes relatively cheap.

Source: Thomson Datastream and Capital economics

Now for the negatives

1.  Inventory
The number of unsold homes continues to be above historical averages and is obviously putting downward pressure on the market. The good news is with the drought in the new home construction, the number of unsold existing homes has been coming down at a good pace.

Source: Thomson Datastream and Capital economics

2. Tight credit
The threshold to qualify for a mortgage has moved up materially since 2008. In particularly looking at the lowest 10% of credit scores that qualify for a mortgage shows a marked tightening (roughly from FICO of 630 to 700.)

 Source: Thomson Datastream and Capital economics

3. Employment
One of the biggest factors holding down the housing market continues to be the employment picture.   The chart below shows the seasonally adjusted "US Continuing Jobless Claims" (or "insured unemployment".)  This measure exhibited signs of marked improvement recently, but as is well known, the unemployed who dropped out of the workforce are not counted here.  And that number remains stubbornly high.

Source: Department of Labor, Bloomberg

We have listed the key quantitative measures that have a direct impact on the housing market. Overall the situation is by no means dire as household formation continues to add to demand and new construction stays weak. One can monitor changes in these measures in order to pinpoint the next move in US home price indices.
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