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Housing Hasn't Hit the Ceiling

By Michael Englund and Rick MacDonald Can the U.S. housing market continue its gravity-defying performance?

At first glance, the July report on existing home sales from the National Association of Realtors (NAR), released Aug. 23, may have provided some fodder for the "must come down" crowd. Sales fell 2.7% on the month to an annualized pace of 7.16 million units -- below economists' median forecast of 7.25 million -- from an upwardly revised record pace of 7.35 million units in June.

But some perspective is in order, as July's report has to be viewed in the context of the sizzling growth in previous months. Indeed, the July drop didn't quite erase June's 2.9% jump. Although the decline was bigger than expected, the 7.16 million annualized rate still represents the third-highest pace on record. Sales still remain at record pace for 2005 and are expected to close at over 7 million, well above the prior high of 6.78 million set last year.

SOME NEW HIGHS. Looking at other components of the July release, single-family sales fell 2.3% to a 6.24 million rate, from 6.39 million in June. Condos and co-op sales dropped 5% to a 915,000 rate. The NAR indicated the decline left overall inventories at the highest level since May, 1988, although as a percentage of sales, supply sits at an innocuous 4.3 months.

But not all the figures were negative. Prices jumped to new all-time highs, with the median price for the nation as a whole rising 14.1% year-over-year to $218,000, and the average price increased 9.9% in that period, to $267,000.

The median rose despite the seasonal cooling of pressure -- the easing should prompt declines in adjusted data through the second half of the year, following bloated midyear readings driven by extraordinary demand for homes at the seasonal peak.

SOUTHERN SALES STRENGTH. While price gains are expected to remain in double digits over the near-term, some reversion to a more sustainable growth trend is likely through the second half of the year, which would also allow sales figures to more closely correlate with the more stable pattern in new home prices.

As for regional sales, the Northeast dipped 3.2%, the Midwest was off 1.7%, the South was flat, and the West dropped 7.5%. Nevertheless, the housing data continue to show broad-based robustness in sales in regions both with and without "bubble" effects. Sales strength continues to be led in the South, which is the only region without a monthly decline from a hefty June activity level, and the region with the highest year-over-year growth -- at 5%.

The existing home-sales moderation in July occurred alongside a sideways move at robust levels for housing starts in July, a drop in completions in both June and July from a May peak, and what we expect will be a drop in new home sales from the hefty 1.374 million June peak.

CALLING THE TOP.Overall, most market economists entered 2004 (and 2003...and 2002...) expecting a drop in housing activity for the year, given the enormous "overshoot" of activity through the recession, but the sector keeps setting new highs. This sequence has been repeated in 2005. We expect this year to mark the peak in the housing sector, as the mix of underlying fundamentals remain supportive through the seasonally important spring market for housing.

We at Action Economics would note that boom periods have extended well beyond the emergence of public perception that prices in these markets are "too high." Though such an assessment is likely correct for some urban markets, calling the top won't be easy until we see signs that price declines are actually emerging, and any pop in the bubble may not occur until 2006 or 2007 -- depending on the course for Fed policy and market interest rates.

Englund is chief economist and MacDonald global director of investment research and analysis for Action Economics

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