The Glass Half Full

There is an abundance of negative information in the daily news that overshadows some very positive developments in our domestic economy. This article reviews three metrics that point to a better economy going forward: (1) lower gas prices; (2) lower mortgage rates; and (3) increased home sales.

Lower gas prices will have the stimulative effect of a tax cut.

The average price of regular gas dropped to $3.53 a gallon for the week ended June 18, the U.S. Energy Information Administration said, down 10% from this year's peak of $3.94 in early April—the 11th straight week of declines. The average gas price has come down about 40 cents, or 10%, and it is 18% below its level a year ago. With U.S. drivers expected to use about 133 billion gallons of gasoline this year, the 40-cent price break works out to about $53 billion in annual savings assuming the current price stays in place for a full year; however, the savings are likely to be even greater. Many experts are now predicting that gas prices will fall to $3.00 per gallon in the fall. Assuming such a decline, consumers will have more than $75 billion of purchasing power that they would not have had this year if prices had remained at their April highs. When energy prices fall, costs for shipping and raw materials can also ease, benefiting businesses.

Gas prices are the most visible area of price change in the economy. As gas prices have climbed consumers have spent less on restaurants and at shopping malls. In part, this is because they have less to spend. Gas conscious consumers may also put off trips to the mall, thereby curtailing retail sales. CNBC reported the following results of a recent poll:

Notably, 75 percent of respondents reported they have cut back on dining due to higher gas prices. Additionally, more than 70 percent of people said they have combated high gas prices by driving less.

Falling gas prices are likely to reverse that trend and the bulk of the benefits lie ahead of us. Rising gas prices act like a tax increase while falling prices act like a tax cut. Lower prices at the pump have also historically bolstered consumer confidence.

Refinancing will put more money in the pockets of consumers likely to spend it.

We are currently experiencing a refinancing boom. Last month, the Mortgage Bankers Association estimated that homeowners would refinance $870 billion worth of mortgages in 2012. A year ago, they estimated that only $400 billion would be refinanced. The upward adjustment results from the dramatic decline in rates on long term U.S. Treasuries to all time lows. The ten year Treasury now pays out 1.6% interest. In February 2011, it paid out 3.7%, and five years ago it paid out 5.2%.

As long term Treasuries have fallen, 30 year and 15 year fixed rate mortgages have also fallen to historic lows. The interest payment required for these loans is lower now than at any point since these mortgages have been available. The rate currently charged for a 30 year fixed rate loan is 3.66%, according to Freddie Mac. The average rate for a 30 year fixed rate loan in 2011 was 4.45%.

The respected economics site Calculated Risk observed in mid-June:

It usually takes around a 50 [basis points] decline from the previous mortgage rate low to get a huge refinance boom - and rates are there! The 30 year conforming mortgage rates were at 4.23% in October 2010, so a 50 bps drop would be 3.73% - and rates hit 3.66% last week.

Demand for refinancing also has surged in recent months amid a push by the Obama administration to make it easier for homeowners with loans backed by Fannie Mae and Freddie Mac to refinance, even if they don't have any equity in their homes or strong credit. That initiative, called the Home Affordable Refinance Program, has accounted for as much as one-third of refinance applications in recent weeks, according to the Mortgage Bankers Association. In mid-June the Mortgage Bankers reported that refinancing applications had reached their highest level since 2009, when rates were falling rapidly. Refinancings in 2012 are expected to add more than $20 billion in consumer purchasing power.

Housing sales appear to be recovering, and modest price appreciation can be expected.

It has been a long time coming but there is increasing and solid evidence that the housing market has bottomed out and that modest home price appreciation can be expected in the coming year.

New home sales are up: New home sales have averaged 353,000 over the first 5 months of 2012, after averaging fewer than 300,000 for the previous 18 months. In May, sales of new single-family houses were at a seasonally adjusted annual rate of 369,000, still low by historic standards, but 19.8 percent above the May 2011 level. With the help of low interest rates, the new home markets may have finally turned the corner.

Existing home sales are up: 4.55 million resale homes sold in June, up 9.6% from the prior year. There was also a 20% decrease in the inventory of resale homes available for sale.

Non-distress sales are up: Moreover, there was a 20% increase in sales of new and resale homes priced over $250,000. This year over year increase signals a revival in the housing market since most homes purchased for over $250,000 are not foreclosures or short sales. They are primarily move up buyer purchases. New home sales are also not distressed sales. The 20% increase in both these categories reflects pent up demand, historical low rates for fixed rate mortgages, and some wage growth since the housing market peaked in 2007. As sales increase and prices creep up, homeowners will regain confidence in their financial status, which should increase their willingness to consume.

Predictions are more positive: Most economists, especially housing economists, predict that the housing market has now reached a cycle bottom after a five year decline. There is debate about how vigorous the market will be going forward. However, the recent sales figures suggest that the recovery may be more robust than many analysts are now forecasting.

The bottom line for the macroeconomic investor is to keep in mind these positives in the face of all the negative reporting on the economy. A cut and run strategy may end up being a big mistake.

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