Sunday, June 15, 2008

Home Improvement Break Down

by Bill McBride on 6/15/2008 07:02:00 PM

There was a blurb in the WSJ last week about hedge-fund manager Edward Lampert: Lampert Puts Money On Housing Rebound.

Although Lampert invested in several housing related stocks, the vast majority of his housing related investment is in home improvement (specifically Home Depot).

Let's take another look at home improvement (Important Note: this is not investment advice). Home Depot recently held an investor conference on June 5th, and here is the presentation material from CEO Frank Blake (hat tip Dave). In general I think Mr. Blake was very realistic about the tough economic environment for home improvement.

The first slide from Mr. Blake is very familiar to readers of CR:

Residential Investment as Percent of GDP Click on graph for larger image in new window.

This graph shows residential investment (RI) as a percent of GDP for the last 60 years. Blake has added the average of 4.8% on the graph, and clearly RI is well below the average.

Note: I usually present the last 50 years, and the average is closer to 4.6%.

This might convince some people that the end is near in the slump in RI. But let's break it down by two key components of RI: new single family structures and home improvement.

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The next graph shows residential investment in new single family structures as a percent of GDP.

Residential Investment Single Family StructuresAs everyone knows, investment in single family structures has fallen off a cliff. This is the component of RI that gets all the media attention - although usually from stories about single family starts and new home sales (related to RI in single family structures).

Currently investment in single family structures is below 1.6% of GDP, significantly below the average of the last 40 years of 2.4% - although still above the low in 1982 of 1.2%.

But what about home improvement?

Residential Investment Home Improvement The third graph shows home improvement investment as a percent of GDP.

Home improvement is at 1.3% of GDP, off the high of 1.4% in Q1 2007 - but still well above the average of the last 40 years of 1.07%.

This would seem to suggest there is significant downside risk to home improvement spending over the next few years.

And finally, Mr. Blake presented this graph on subprime and Alt-A mortgage origination.

Worst of Mortgage Mess Behind Us?This shows the stunning surge in subprime and Alt-A lending starting in 2004 and running well into 2007.

The graph is captioned: "The worst part of the mortgage market is behind us", but it probably should have been captioned "Worst part of mortgage origination is behind us".

The fallout from these poorly underwritten loans happens when these houses fall into foreclosure, and delinquency and foreclosure rates are still rising - and rising sharply for Alt-A and even prime loans. The worst of the origination is definitely behind us, but the worst of the impact on the economy from this poor underwriting is probably still to come.

Read on ... there is much more.