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To feel better, look elsewhere than the U.S. home prices train wreck

02/29/2012 by Alex Carrick, RCD Canadian Chief Economist

While there is reason to be more optimistic about the U.S. economy – and this will be examined further along in this report – there are certain bundles of information that still make one cringe.

For example, prices in the existing homes market remain a disaster. The S&P/Case-Shiller resale home price index report for December was a shocker. The national, 10-city and 20-city composite indices have all reached new lows.

Resale home prices in the U.S. are now at about the same level as they were in 2002.

Versus their peak in June/July 2006, all three indices are -33.8%. Furthermore, given the extent of foreclosure activity, they are continuing to slide. The 10-city and 20-city composites both fell 1.1% in December compared with November. Their year-over-year changes were about -4.0%. 

Over the next several years, it will be interesting to see how the housing market collapse affects the asset mix homeowners choose to pursue. Owning one’s own home used to be the bulwark of a family’s wealth. Will this mean a greater turn to equity markets? Will more people be inclined to rent their accommodation rather than purchase?

Analysts are already pointing to rental markets as the new growth area for housing in the U.S.  

If one can tear one’s attention away from the housing market train wreck, however, one will notice that there are many other economic indicators that are trending upwards.

For example, the Conference Board’s Consumer Confidence Index made a strong advance in February to 70.8 from 61.5 the month before. That placed it at a level close to its post-recession high of 72.0, which was achieved twelve months ago, in February 2011.

The index has climbed nearly 30 points in the last four months. The fact the economy has created one million net new jobs since mid-2011 has been a major contributor to greater optimism about the future.

The index dropped as low as 25.3 at the beginning of 2009 when the recession was at its most devastating.

As for the answers to some of the Conference Board’s specific survey questions, the percentages of respondents thinking business conditions are good (from 13.2% to 13.3%) and that jobs are plentiful (from 6.2% to 6.6%) have risen.

This isn’t to deny there’s room for improvement. The proportion of consumers who still think business conditions are bad (31.2%) is vastly greater than those thinking they’re good (13.3%). It’s a similar pattern for jobs, with those thinking they’re “hard to get” (38.7%) much greater than those who think they’re in abundance (6.6%). 

However, not only has the percentage of respondents who think business conditions will improve over the next six months increased (from 16.7% to 18.7%), it’s also at a percentage level that’s higher than for those who don’t (11.8%). And the same goes for the percentage who think there will be more jobs in the months ahead (from 16.4% to 18.7%) versus those who think there will be fewer (16.9%).

The Purchasing Managers’ Index (PMI) of the Institute of Supply Management (ISM) also offers encouragement. For the 32nd month in a row, it was over 42.6% in January, indicating that both the economy and the manufacturing sector in the U.S. are expanding.

Historically, the current level of the ISM, at 54.1%, corresponds with “real” (i.e., non-inflationary) growth in gross domestic product (GDP) of +3.9%.

Something everyone’s watching with a cautious eye is the world price of oil. It has moved back close to $110 U.S. per barrel. Higher gasoline prices are definitely not what the economy needs right now. In the meantime, in Canada, the economy is muddling through. This is despite the distractions of unwarranted and ungracious statements by some of our political elite.

Ontario Premier Dalton McGuinty is surely feeling under siege for the recommendations contained in the Drummond report, which sets out wide-sweeping measures the province must take to get its costs back under control. The deficit and debt have grown to alarming proportions.

The report, in essence, is a condemnation of how far off track the provincial government has managed to take the province’s finances. There will be a bleak future for the people of Ontario without considerable belt-tightening. Rating agencies have already warned of another potential debt-ratings downgrade.

How else to explain why McGuinty has thrown on a cape and tried to transform himself into a magician? Furthermore, his magic act doesn’t go in a direction one would expect – an effort to make the deficit and debt disappear. Rather it’s all about misdirection.

The Premier has said that given a choice between higher oil prices that would be of benefit to Alberta, or a weakening in energy export markets that would lower the value of the Canadian dollar for Ontario’s manufacturers, he’d take the latter.

This is pass-the-buck, blame-the-other-guy politics, pure and simple. It doesn’t take into account what’s best for Canada as a whole. It doesn’t even consider what’s best for Ontario.

It overlooks the benefits to Ontario industry from massive investments in the West that are repatriated in service sector and industrial jobs.

It ignores the financial contribution that Alberta is making to support national social programs. This has taken on more important since Ontario became a “have not” province.

It ignores the sweep of history that is seeing the rise to prominence of Asia-Pacific, with all that means in terms of demand for this nation’s raw materials.  

It suggests that the commodities that are in Ontario’s own possession (precious and base metals agricultural and forestry products) are of secondary importance.

Ontario clearly has problems it must address in its own domain. These include a non-competitive cost structure, both in industry and in the public sector, and an energy policy that has driven up electricity costs while doing little to alleviate the threat of power shortages.  

And it ignores the fact that Ontario is a whole lot more than manufacturing. It’s those strengths – in the financial sector, academics, entertainment, tourism and even northern resources – where imaginative and aggressive thinking would do the most good.

When the Canadian dollar was at $0.65 U.S. ten years ago, that was not a positive statement about the nation’s economy. Government debt, relative to other nations, was out of control.

The fact the loonie is now at parity with the greenback should be a source of pride, never mind what it means in terms of keeping our import cost structure down and raising our opportunities to travel and invest abroad.

Purchasing Managers Index (PMI) - U.S. Institute of Supply Management (ISM)
(seasonally adjusted)
Purchasing Managers Index (PMI) - U.S. Institute of Supply Management (ISM)
The ISM reports that the January 2012 PMI value of 54.1%, when annualized, has historically correlated with "real" (i.e., inflation-adjusted) GDP growth of +3.9%.

*The solid red horizontal lines show the benchmark levels of 42.6% and 50.0%. History has established that below 42.5%, both manufacturing and the overall economy are contracting; from 42.5% to 50.0%, manufacturing is contracting, but the overall economy is expanding; and above 50.0%, both manufacturing and the overall economy are expanding.
Data source: Institute of Supply Management / Chart: Reed Construction Data - CanaData.


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