The Real Estate Bubble (2004-06) and Bust (2006-09), and the Bull Market’s End and Recession’s Start (2007)
The above sequence was definable and predictable, as evidenced by these excerpt from the following Letters:
July 1, 2005, DJIA 10,275: You hear talk of a possible recession, which is of course possible, but is NOT probable in the foreseeable future. Even the price of oil at current levels will not cause one, and the other problem of a real estate bubble, while currently occurring does not look to end immediately or to be the cause of a recession unless it ends with an implosion, which is highly unlikely. So there you are, left with a stock market that does not seem to want to go up or down significantly. It IS boring, but we’ve seen boring before (nearly every summer), and that alone is not a reason to abandon the market. Time is on the side of this market, and timing is on your side, so let’s let it play itself out.
April 1, 2006, DJIA 11,109: We can’t anticipate the next terrorist attack but we can anticipate the next recession – there WILL be one – quite possibly in the next year or so! A contributor to a recession will likely be the unemployment increase due to layoffs in the home-building industry. U.S. Dept. of Labor statistics show that the real estate construction (& extraction) industry has gained over one percentage point of the total national employment pool (from 5.4% to 6.6%) over the last couple of years. Adding in the increases in real estate agents, mortgage brokers, etc, sets a new record for employment in the total real estate industry. A return back to pre-boom employment levels in that industry would by itself raise the national unemployment rate by well over 1%. As you know from the Special Report on Rising Unemployment only a 4/10th of 1% increase (on a 3 month moving average) has signaled recession all 10 times since 1948. I am not expecting that the rise last month from 4.7% to 4.8% was signaling the start of a further increase but it bears watching. I, frankly, would think there will be a delay in the slow down before lay-offs would reach levels which would cause a recession, but we shall see. And so, we watch and wait and in the meantime stay fully invested.
July 1, 2006, DJIA 11,150: The housing bubble is clearly deflating and that means the ‘wealth effect’ will be reduced which could affect consumer confidence in the future. That is important because the consumer directly impacts 2/3rds of the economy and the index is one of our ‘Three Tops and a Tumble” indicators. Unless other industries can pick up the unemployed from a slowing housing industry, there would be an increase in unemployment which is one of the signs of a recession. We are on a “bull market top and recession watch” because of the “Three (possible) Tops”.
September 1, 2006, DJIA 11,381: What would cause a recession, you say?? The headline from the Arizona Republic, 6/9/06 says it all: “Housing skid hurts other sectors of the economy”: 1) The first ripple: Builders take a hit, 2) Subcontractors get caught in slowdown, 3) Real Estate agents rethink careers, 4) Fewer sales equals less title work, 5) Land brokers are losing deals, 6) Retailers see sales slipping, 7) ‘Stagers’ (they ‘spiff-up’ houses for sale) reap a boost in business, 8) Landlords benefit from rise in renters, 9) Foreclosure firms get ready for a boom, 10) Vacation markets take a hit, and 11) Consumers stuck in a slow market. Since then they have added “Restaurant chains blame high gas prices, economy for decline in customers”. I’m sure you have seen (or will be seeing) such stories in your area. Granted the housing boom in Arizona was among the strongest anywhere and the fact that “Valley resales plunge” (AZ Republic, 6/9/06) should have come as no surprise. You probably saw the unemployment rate in July rose from 4.6% to 4.8%. As I wrote in the April Letter “A contributor to a recession will likely be the unemployment increase due to layoffs in the home-building industry”. None of this adds up to a recession NOW, but the economy IS moving in that direction.
November 1, 2006, DJIA 12,080: Obviously there will be another recession; it is only the timing that is in question. I first showed the relationship of housing starts leading the economy into, and out of, recession back in 1989 before the 1990-91 recession. In the April Letter I wrote that “A contributor to a recession will likely be the unemployment increase due to layoffs in the home-building industry”. The current situation should have all eyes zeroed in on the possibility of housing starts once again pointing to recession:
December 1, 2007, DJIA, 12,221: In last month’s Letter I pointed out two other tops of concern, housing starts and the Transportation index. For the fourth time in the last 45 years housing starts have dropped from above 2,200,000 starts to 1,500,000. On each of the prior occasions a bear market and recession followed! One would think this chart would have an upward bias to it given our increasing population and increasing needs for housing, but it doesn’t……the home building slump has gotten worse faster than most predicted. Two weeks ago, Standard and Poors estimated that housing starts would drop to 1,500,000 in early ’07 from the then current 1,740,000. Actually, the very next day they were reported to be only 1,486,000. This past Monday the Wall Street Journal wrote “How Housing Slump is Risk to Big Three Rebound” and that “an increasing number of forecasts say (auto) sales could fall next year to their lowest level in nearly a decade.” So the broadening out of the burst real estate bubble is indeed occurring in late 2006. I expect we’ll see more evidence of an approaching recession as the new year progresses.
January 1, 2007, DJIA 12,463: I continue on a “bull market top and recession” watch, and by definition – if nothing else – they are getting closer. Keep your eyes open and dance toward the exit, but so long as the music keeps playing just keep on dancing. It should become clearer as 2007 unfolds whether or not the economy will have a soft landing or a recession. The consumer will likely decide the outcome. If they continue undeterred by world affairs and potential domestic problems, they can keep the economy chugging along. If they pull in their horns for whatever reason, perhaps a reverse wealth effect due to thehousing market, then a recession is likely.
April 1, 2007, DJIA 12,354: On the other hand, as economists are wont to say, the chances of recession are indeed high thanks to the yield curve and the housing bust. Even there, some say there is no bust because existing home sales are recently up and they account for 85% of all home sales. Unfortunately, there is a large margin of error in those figures and new home sales are certainly down. You’ll remember from last September’s Letter, seven months ago, that under the headline “Housing skid hurts other sectors of the economy”, there were 11 events that could take place. 1) The first ripple: Builders take a hit, 2) Subcontractors get caught in slowdown, 3) Real Estate agents rethink careers, 4) Fewer sales equals less title work, 5) Land brokers are losing deals, 6) Retailers see sales slipping, 7) ‘Stagers’ (they ‘spiff-up’ houses for sale) reap a boost in business, 8) Landlords benefit from rise in renters, 9) Foreclosure firms get ready for a boom, 10) Vacation markets take a hit, and 11) Consumers stuck in a slow market. By my count, all eleven have occurred. The surprising thing about the housing bust is that construction employment has dropped only slightly, so far.
August 1, 2007, DJIA 13,212: Thus far a decrease of construction employment has failed to materialize, but assuming the same lag time to the collapse in housing starts, employment will almost assuredly begin to drop in time. Nearly 1 million in lost jobs would appear possible, and that alone would increase the unemployment rate from February’s low of 4.4% to approximately 4.9%. Such an increase in unemployment has previously been associated with recessions. See the Special Report on Rising Unemployment. That would, of course, be the impetus for a bear market which would precede a recession.
August 14, 2007, DJIA 13,029: When the situation changes investors need to change with it. The Dow Theory gave a Sell signal today. That points to selling one-half of your stock market exposure to a stance of ‘half IN, half OUT. That’s my ‘When in doubt’ posture. What does it mean – a bear market and a recession? Yes, that is the usual result. As you know, we have seen a possible future recession coming since the February 2006 Letter when the Yield Curve inverted. We did not expect one to “start in 2006, it is not unlikely for one to occur in 2007 or perhaps not until 2008”. Also in the April 2006 Letter we recognized the housing bubble burst would eventually lead to layoffs in the construction industry which would eventually start to increase the unemployment rate overall. Then this April’s Letter showed the increase in nonfarm payrolls was slowing and that the number of employees in the construction industry was level at best. Last month we showed the lagging effect of construction employment to the trend in housing starts. The reason for those concerns is evident in the following chart. It sure looks to me like another ‘shaded area’ will appear soon, i.e. a recession is in sight.
October 9th, 2007, DJIA 14,164: Bull market top, Bear market begins.
December 2007: Recession officially starts.