Fasten Your Seat Belts in '06

Housing prices look like tech stocks at the height of the dot-com boom, so expect a nasty slump. Meanwhile, bet on tech to soar

Forecasting is a fool's game. The economy has enough unpredictable twists and turns to make anyone look stupid. But in the spirit of the New Year, I'm going to give in to temptation and offer up not one, but two predictions: 2006 will be a terrible year for housing. However, it will be a great one for technology. (Take notes out there, all you home buyers and stock market investors.)

Let's look at the facts:

Fact #1: The housing bubble is now officially bigger than the tech bubble ever was. At the peak of the frenzy in 2000, consumer and business spending on tech software and hardware absorbed 6% of economic output. Today, residential construction takes 6.1% of output -- that's the biggest share of the economy devoted to housing since 1955. And remember, that was smack-dab in the middle of the postwar baby boom. (For a chart, see my blog.)

Fact #2: The share of the economy going to technology, at 5%, is no higher today than it was in 1997, before the Internet boom really got going. To put it a different way, in the midst of a technological revolution of historic proportions, spending on tech has grown no faster than the overall economy. It's hard for me to believe that this pattern will continue.

Fact #3: Home-building stocks have quadrupled in price since 2001. That's almost as great as the runup in tech stocks from 1997 to the peak in 2000. Haven't we learned anything?

Fact #4: Tech stocks overall are no higher than they were at the beginning of 2004. The same is true for telecom stocks.

I put this all together and draw several conclusions. The housing bubble could well trace the same path as the tech bubble: A big rise that convinces even the skeptics to invest -- this time in real estate -- followed by a sharp decline that exceeds even the worst of fears.

Just as the overspending on tech and telecom in the late 1990s set the stage for the big tech bust, the rapid pace of residential construction suggests that we could easily end up with a nationwide oversupply of housing, even if mortgage rates don't rise much.

BUYING SPREE. And don't listen to people who tell you that because everyone needs a place to live, housing is more bust-resistant than technology. In 2000 and 2001, the conventional wisdom said that technology spending was recession-proof because companies couldn't afford to cut back.

In fact, businesses suddenly realized that they were spending more on info tech than they needed, even as the tech industry was assuming that the 1990s buying spree would continue and expanded its capacity. Oversupply met reluctant demand, and the bust followed.

This time, the result of oversupply will be equally grim: Home prices will fall sharply in many areas, not just go flat. I even expect the national price for homes to decline by a bit. Construction and mortgage lending will slow sharply, and the whole psychology of the real estate market will change. Homebuilding stocks will give back most if not all of their astonishing gains. This will not be pretty.

ON THE UPSWING. On the other side of the ledger, there's a good chance the tech sector will finally snap out of its post-bust funk. Here are some encouraging signs: Telecom is actually adding jobs, on a year-over-year basis, for the first time since 2001. Computer systems design firms are expanding as well, and wages for programmers are apparently on the upswing, especially in Silicon Valley.

Online advertising is projected to rise by more than 30% in 2006. And there's a sense of excitement that hasn't been present since the boom years, as companies like Google (GOOG ) and Apple (AAPL ) dominate the headlines. The end result should be a rise in tech and telecom stocks -- not of biblical proportions but certainly enough to be enjoyable for investors.

What will this mean for the whole economy? Overall, growth should continue and the stock market should rise. But when a bubble bursts, the turbulence hits everyone. Hold on tight for a rough ride.

Mandel is chief economist for BusinessWeek. See his blog, Economics Unbound, for more about his views of the future. http://www.businessweek.com/the_thread/economicsunbound/
Edited by Patricia O'Connell

BW MALL SPONSORED LINKS

Mutual Funds at Fidelity Benefit from years of mutual fund management experience.
High interest checking only online! 2.02 APY, FDIC insured, mobile banking and no fee bill pay. Incredible!
OppenheimerFunds. Products and Services For A Range Of Financial Goals. Learn More.
Online PHR Certificate Program w/ Villanova Univ SHRM Approved HR Certificate Program from Villanova University. 100% Online - Find Out More Now!
Email Marketing with iContact New Businesses are shifting their marketing spend to email marketing: Are you?

Buy a link now!

Get BusinessWeek directly on your desktop with our RSS feeds. XML

Add BusinessWeek news to your Web site with our headline feed.

Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video.

To subscribe online to BusinessWeek magazine, please click here.

Learn more, go to the BusinessWeekOnline home page