Magazine

U.S.: The Housing Grinch Won't Steal Christmas


'Tis the season--for retailers, that is. It's make-or-break time, and it all starts on Black Friday. That's what the industry calls the day after Thanksgiving, when the initial surge in holiday buying puts everyone's bottom line "in the black." Store receipts over the next few weeks typically account for about 20% of retailers' annual sales and an even greater percentage of the year's profits. The question is, will consumers fork over the money? That's a special concern this year, given the worries that the housing slump might cut into the action.

Retailers can put their fears behind them--and that's good news for the overall economy this quarter and next. Consumers are heading into the holidays buoyed by the sturdiest set of spending fundamentals in years. The labor markets are strong, with the unemployment rate at a 5 1/2--year low of 4.4%. Gasoline prices are down 26% since early August, resulting in a windfall of purchasing power for household incomes. Stock prices, based on the Standard & Poor's 500-stock index, are up 13% since July, and confidence measures are generally upbeat.

There is still almost no evidence of spillover effects from the housing downturn on consumer buying. That means the slump remains confined to the housing sector. Sharply lower home construction is a big drag on economic growth, but consumers are providing a crucial offset. Although some signs indicate housing demand is stabilizing, builders are still getting hammered, as seen in the steep 14.6% drop in housing starts from September to October, to the lowest level in more than six years.

That plunge in starts assures there will be another sizable hit to overall growth this quarter from cutbacks in residential construction. In the third quarter, homebuilding subtracted more than a full percentage point from the growth in real gross domestic product, and this quarter's bite will be just as big. However, based on the latest readings on retail sales and consumer prices through October, consumer spending in the fourth quarter is speeding up.

RECENT GOVERNMENT REPORTS on retail sales require a careful reading. October sales dropped 0.8% from September, when they fell 0.2% from August. Those declines mainly reflected back-to-back decreases in gas station receipts of 11.1% and 6%, indicating lower pump prices, not less gasoline buying.

In addition, retail sales of building materials and supplies fell for the third consecutive month. For purposes of measuring GDP growth, though, the government counts that activity as part of residential construction, not consumer spending. Overall retail sales from July to October fell at a 4% annual rate, but sales excluding gas and building materials grew at a healthy 5.1% rate. The bottom line is that consumer spending on most items began the final quarter with a head of steam, fueled largely by the additional buying power fueled by falling energy prices.

THAT BOOST WAS EVIDENT from the overall consumer price index in September and October. It posted monthly declines of 0.5% in each month, the largest two-month drop since 1948. The fourth-quarter CPI will actually be below the level for the previous quarter, a rare event in the past half century.

That means the same paycheck this quarter will buy more goods and services than it did last quarter. For example, the Labor Dept. reported that real weekly earnings of production workers in October increased 1.3% from September, when they rose 1% from August. Those were the biggest back-to-back gains in 24 years.

Consumer momentum is the chief reason retailers shouldn't fret about the housing slump spoiling their holiday party. Clearly, some of the housing-related data of late have looked alarming, especially the surprisingly large drop in October housing starts. But that decline might have been an exaggeration. The huge 26.4% plunge in new home starts in the South was one of the largest on record for that region. Several analysts say the swoon might have been due to exceptionally wet weather in that region. If so, the weakness may well reverse in November.

Right now, it is important to separate the demand-side reports from those on the supply side. Several sales indicators appear to be stabilizing even as builders work through their stocks of unsold homes by cutting new construction and prices. Construction cutbacks will most likely continue through the winter, but the apparent bottoming out on the demand side is an important barometer of the eventual turnaround in new building.

Strengthening demand is particularly noticeable in the new-home market, where sales increased in both August and September, the first two-month rise in a year and a half. Lower mortgage rates and the increasing willingness of sellers to drop their prices are a big part of the story. Rates for 30-year fixed mortgages have declined from a national average of 6.86% in June to 6.15% on Nov. 10.

THE MOST FAVORABLE SIGN that demand for homes will continue to firm comes from weekly mortgage applications to buy a house. Not only have applications stopped falling, their three-month average is now rising after declining steeply for more than a year. The applications statistics foreshadow data on housing sales, and sales are what drive new building.

Even builders are starting to see some movement on the part of buyers. After hitting a 15-year low in September, the index of housing market conditions, based on a survey by the National Association of Home Builders, edged up in both October and November. The NAHB surveys builders on current sales, expected demand, and buyer traffic through model homes. Their November report on current sales edged up slightly, but sales expectations rose significantly, and they noted increased traffic of prospective buyers.

While builders work through their problems, the economy is also getting plenty of support from businesses expanding their operations. Look at the rising trend of orders for capital goods and the recent increases in industrial production of business equipment.

Factory output, down 0.2% for the second month in a row in October, has been faltering under the weight of cutbacks in the auto industry and falling demand for construction supplies. Yet monthly production of business equipment posted a strong gain, as did output of high-tech equipment such as computers and peripheral equipment, telecom gear, and semiconductors. Production of aerospace equipment was also strong. Capital spending and outlays for business construction will be other key areas of support for the economy this quarter and next.

On balance, the holiday season is shaping up nicely for the economy. With gift cards selling at a brisk pace, retailers should be merry well into the new year as revenues from the gift-card business show up in January. The only place to look for the Grinch is in housing, but even there, scattered signs offer hope for better times in 2007.

By James C. Cooper


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