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Housing: Still Flooded
By: Zacks Investment Research   Monday, August 2, 2010 2:41 PM
Symbols: BAC, DRI, JPM, MCD, RIG
The other two poster children for the housing bubble -- Florida and Arizona -- are not in quite as bad shape; to get to half of all homeowners underwater, you need to include even those that are just "damp" on their mortgages.  Still, that is a lot of people who are underwater.



Housing wealth is -- or at least was, before it all evaporated -- far more widespread and "democratic" than stock market wealth. For many people, the equity in their houses was a form of "forced" savings that was going to be a big part of retirement plans, or the way they were going to put their kids through college. Now either they have to abandon those plans ("Sorry Billy, I know you worked hard in high school and got into the Ivy league like you always dreamed, but you will just have to go to community college instead,") or people are going to have to save a lot more out of current income.

As the savings rate rises, it means people will spend less at the stores, particularly on discretionary items. It means fewer meals out, and when people go out, it means it is more likely to be at McDonald's (NYSE: MCD) than it is at Red Lobster [part of Darden, (NYSE: DRI)].

Of course, it is hard to save when you are out of work. It is only the 90% of the workforce that does have jobs that have any real hope of saving. As they scramble to do so, the lower demand is likely to cause more unemployment. If people are not going out the Red Lobsters of the world, then there will not be as many people working as waiters. busboys and cooks.

Since people have a greater tendency to view housing equity as "permanent" wealth relative to stock market wealth (where people know a correction can come along at any point), the negative wealth effect from a decline in housing prices is greater than a similar decline in stock prices. It is estimated to be between 5 and 7%.

In other words, if the value of your house goes down by $10,000, you are going to spend between $500 and $700 less in the subsequent year. It is not just those that are underwater who have lost housing wealth, and if you multiply that $500 to $700 across tens of millions of homeowners, you have a very big dent in consumer demand.

The future course of housing prices -- and with it the savings rate -- and consumer spending are a far bigger source of uncertainty than anything surrounding future regulations or taxes. If businesses don't think the consumer demand will be there, they are not going to invest, particularly at a time when there is lots of excess capacity, as there is now.

Corporate profits are doing extremely well; so far the earnings of the S&P 500 are up 44% year over year with 2/3rds of results in. However, if the demand is not going to be there in the future, corporations will simply sit on the cash, or perhaps use it for dividends and share repurchases. The only investment that will be desired will be investments that raise productivity and cut costs (and jobs). This is the key reason why we have such slow growth right now.

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.


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