Despite the tough times in housing, the economy continues to grow, and that will make the recovery in housing happen much sooner. The energy sector, in particular, is thriving, spurred by a falling dollar and skyrocketing commodity prices.

Despite the tough times in housing, the economy continues to grow, and that will make the recovery in housing happen much sooner. The energy sector, in particular, is thriving, spurred by a falling dollar and skyrocketing commodity prices. Many other segments of the economy remain in good shape as well, as seen in our chart of year-to-date industry stock performance below.

The economy grew at a very strong 3.9 percent growth rate in the third quarter, with consumer spending, exports, business investment, government and inventories all growing and offsetting the heavy decline in housing.

Our grading system of the economy and the housing market is a “bell curve” model, with statistics at an all-time high receiving an “A,” statistics near the long-term average receiving a “C,” and the worst times ever receiving an “F.” In this grading system, it is OK to be a “C” student.

Here is our current report card:

Economic Growth: C

The economy is performing at a steady pace, evidenced by a higher-than-expected 3.9 percent GDP growth rate during the third quarter and a strong employment report in October. The unemployment rate remains low, though mass layoff events did experience a sequential uptick and will most likely continue to increase in the coming months due to housing and financial sector woes. Retail, productivity and federal deficit indicators improved this month, while personal income experienced a marginal decline. Core CPI — a key inflationary gauge — remains unchanged at 2.1 percent.

Leading Indicators: C-

Almost all of our leading indicators softened this month, highlighted by higher oil prices and a flight to quality in treasuries. Yields on 10-year and 2-year treasuries declined, and the yield curve continued to widen, with investors favoring safer short-term securities. Sectors such as technology are performing very well, with the NASDAQ leading all major indices in terms of year-to-date gains. Residential investment as a percentage of GDP fell again in Q3, dropping below its historical average for the first time since Q1-2002. Home builder stocks improved slightly in October, but are still in the red, with the S&P Super Homebuilding Index down 45 percent over the last year.

Mortgage Rates: B

In October, the Federal Reserve cut its benchmark interest rate by a quarter-point to 4.5 percent. Fixed mortgage rates declined for the third month in a row during October, while adjustable rates were unchanged, narrowing the spread. The 30-year fixed mortgage rate ended the month at 6.33 percent, while the one-year adjustable rate stood at 5.66 percent. As reported by the Mortgage Bankers Association, the percentage of mortgage loan applications with an adjustable interest rate increased to roughly 15 percent in October. The subprime credit market continues to worsen, as evidenced by the still-declining ABX 06-2 BBB- series, which has fallen roughly 80 percent year to date.

Consumer Behavior: C+

All three gauges of the consumer weakened in October, but remain healthy. Consumer confidence fell to 95.6 in October, a low not seen since October 2005, but remains near historical averages. Consumers continue to increase credit card spending, a trend that we foresee continuing through the foreseeable future now that home equity extraction is becoming more difficult for borrowers.

Existing-Home Market: D

Conditions in the existing-home market are still deteriorating. Annualized home sales fell to 5.04 million in September, equating to the lowest level since September 2001, with existing-home sales volume now down 19 percent over the last year. In addition, the level of existing-home inventory now stands at 10.5 months, a level last witnessed in July 1985, equating to a precipitous 44 percent increase over the last year. All indicators point towards continued price declines, and it is unlikely that we will stray from continued pricing pressure in the coming months. Lastly, the homeowner vacancy rate increased during Q3-2007, while the home-ownership rate fell for the fourth consecutive quarter, representing the longest string of declines ever for this indicator — dating back to 1965. Affordability and ARM reset problems continue to favor rental household growth over homeowner growth.

New-Home Market: D-

The new-home market continues to remain weak, with builder confidence now at an all-time low, as the NAHB’s Housing Market Index fell to 18 in October. Since its peak in June 2005, the Housing Market Index has dropped 75 percent. New-home sales volume increased to an annual rate of 770,000, and the supply of unsold new homes declined to 8.3 months, while median new-home prices increased 5 percent over the past year. Census Bureau new-home metrics are notorious for drastic revisions, so we do not put much weight in the slightly better numbers for this month alone.

Housing Supply: D

Builders continue to pull back on new supply, which will help the housing market in the long run. Permit activity has fallen to a 1.22 million-unit annual rate, with single-family permits declining to 868,000. Single-family permit activity is now at its lowest point since April 1992, while total permit activity is at its lowest level since March 1995. Starts continue to decline as well, falling to 1.19 million in the last 12 months. Housing completions decreased again to 1.39 million, equating to a 31 percent drop over the last year.

John Burns is the founder of Real Estate Consulting in Irvine, Calif., which monitors changes in real estate market conditions and provides consulting services, including strategic planning, market research and financial analysis. He can be reached at jbrec@realestateconsulting.com.

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