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Thursday, July 05, 2007

Kasriel: Housing Recession Starting to Strangle the Consumer

by Calculated Risk on 7/05/2007 04:13:00 PM

Northern Trust's Paul Kasriel writes: The Tentacles of the Housing Recession Are Beginning to Strangle the Consumer

Light motor vehicle sales in the U.S. dropped 3.4% month-to-month in June to a seasonally adjusted rate of 15.6 million units. Excluding the Katrina-depressed sales of September 2005, the June 2007 sales rate was the slowest since September 2002. Light motor vehicle sales have declined sequentially for six consecutive months. On a quarterly average basis, new light motor vehicle sales contracted at an annual rate of 12.7% in Q2 vs. a 6.2% increase in Q1. Although not all of the Q2 decrease will show up as a subtraction to consumer spending (some will subtract from business capex), there are other indications that consumer spending is flagging. As mentioned in our June 26 daily commentary, "So, the Housing Recession Is Contained?", a number of retailers in the discretionary consumer spending “space” have recently reported disappointing sales and have lowered sales guidance. Corroborating these individual retailers’ reports are the Johnson Redbook retail sales survey results for June ... retailing activity tailed off significantly in June. The April-May average of real personal consumption expenditures was up only 1.3% at an annual rate vs. its Q1 average. The June data on light motor vehicle sales and chain store sales are not pointing to an acceleration. The question the markets and the Fed will be wresting with over the remainder of summer is whether the sharp deceleration in Q2 real consumer spending is a one-off event or something with more longevity. My bet is the latter. The ongoing housing recession is sharply reducing one source of funding for household deficit spending – mortgage equity withdrawal (MEW). The continued decline in home prices and the tightening of mortgage underwriting standards will exacerbate the drying up of MEW. Job growth also is trending lower, which will restrain future consumer spending. Slowly but surely, the tentacles of the housing recession are strangling the consumer.
As I asked last week, is the Q2 consumer slowdown related to the housing slump? Kasriel believes it is.

The economy is somewhat schizophrenic right now. Just look at the positive growth stories I posted this AM on ISM services, office rents and employment. And last week, Dr. Altig highlighted the positive ISM manufacturing report and detailed the current fairly positive consensus economic view for the second half of '07.

My view is:

1) Housing appears to be taking another down turn right now, and I expect residential investment to continue to decline.

2) The pickup in manufacturing appears to be due somewhat to exports and mostly because of an inventory correction. The inventory correction appears to be mostly over, and I'd expect less growth from manufacturing going forward.

3) Non-residential structure investment has been very strong this year, but I believe it will slow down later this year.

4) I think it is very likely that Kasriel is correct, and that the Q2 consumption slowdown is related to the housing slump. Since the housing slump is ongoing, and MEW will continue to decline, I expect weak consumer spending in the second half of '07.

When I add it all up, it seems to spell the R-word (or at least very sluggish growth in H2 '07). Maybe non-residential structure investment will stay strong. Maybe consumer spending will rebound in Q3. Maybe ...