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Can the US Economy Recover Without a Housing Recovery?

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It can, and here's what the 'new normal' would look like.

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Can the US economy recover without a recovery in housing? The answer is yes -- and you are just going to have to be willing to accept that the value of your home today is much closer to its true value than, say, the value of it in June 2006.

Economists like to debate whether a US economic recovery can occur in the face of continued pressure on the housing market. Most economists point to past recessions and highlight a correlation with economic recovery and increased spending on homes.

The "mental correlation" is fairly obvious. For most people, their single largest asset in dollar terms is their home – whether you include only the equity or the entire value. It is a key part of the equation of how the average American assesses his own wealth position. The more confidence the average American has in the value of his home, the more likely that confidence will translate to increased spending on other discretionary and non-discretionary consumer purchases.

The actual data correlation between the housing and economic recoveries is reasonably accurate also. Several recent recessions in the last 20 years have seen housing lead the way in powering out of the recession. Just look at the growth of Home Depot (HD) and Lowe's (LOW) in the last 20 years. The growth in home building and housing has been a big boon to the US economy for 20 years, so of course the data "looks" like it shows an industry leading the way out of recession.

But the question still hangs out there: Can our economy recover nicely without a housing recovery? The recent economic data already shows a recovering economy, but housing data doesn't represent any meaningful part of that recovery or growth. There are really no economists predicting a housing boom or recovery any time soon, and yet the economic data has been reasonably reassuring of late (I stress the word "reasonably").

So the question persists: Are we breaking the mold here? Are we going to recover without the housing market recovering? I think it depends on what everyone means by housing "recovery." If the average person thinks that recovery means we are going back to the 2006 peaks in housing prices, then the answer is clear: We will not have a recovery. How far do housing prices have to rebound to feel like a recovery has occurred?

I think the answer is not what most hope for. I think the current prices for housing are very close to the new normal. There will not be a meaningful move up from these prices in the next five years. In fact, prices will likely continue the drop before they go back up. But I think the economy will continue to recover, and the recovery still has the potential to be strong despite a drag from housing.

I think the new normal has already started settling into the psyche of both consumers and investors. I think home owners have realized that housing prices increased too far in too short a time period. I have placed the S&P/Case Shiller Home Price Index since Q1 1987 below:



When you calculate the compound annual growth rate from Q1 1987 to Q4 2011, it works out to 3.1%. If you calculate the compound annual growth rate from Q1 1987 to the peak in Q2 2006, it works out to 6.2%. Which of these seems like the more appropriate growth rate for the value of your home?

Just look at the slope of the two trend lines. The green line looks like the line of the trend in the late '80s and early '90s just continued: normal 3% growth in home values. The red line doesn't really share any slope characteristics with the rest of the chart. Of course, we know the the ill-fated laws that our Congress passed, which drove the housing bubble, started in the mid-'90s and really took hold in the late '90s and early 2000s.

The conclusion: Housing is not going to be part of this recovery. The bubble was artificial – and can't be restored. But the new housing-value normal will settle in to the psyche of the average consumer and investor. It won't be an impediment to the US economic recovery – it just won't be a help, either.

Editor's Note: For more from Wayne Ferbert, go to Buy & Hedge ETF Strategies.
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No positions in stocks mentioned.
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