New Home Sales rose 23.6% in June from May to a seasonally adjusted annual rate of 330,000. However, the May total was revised down sharply from a rate of 300,000 to 267,000. Thus, relative to where we thought we were, the increase was more like 10%.

Relative to a year ago, sales were down 16.7% from last year’s rate of 396,000. On a not-seasonally-adjusted basis, sales were just 30,000 for the month — the weakest June on record.

Results by Region

Regionally, based on the seasonally adjusted numbers and the revised May figures, the biggest increase was in the Northeast where sales jumped 46.4%, and were up 17.1% from a year ago. The Northeast is the smallest of the four census regions for housing data, and even with the big increase for the month it accounted for just 12.4% of all new home sales, up from 10.5% of sales in May.

The next best performance, however, came from the largest region, the South, where sales rose 33.1% on the month but are still down 6.1% from a year ago. The south was responsible for 56.1% of all new home sales, up from 52.1% in May.

Sales in the Midwest region rose 20.5% on the month and are down 20.3% from a year ago. The worst performance by far was in the West, where sales fell 6.6% for the month and are 45.7% below last year.

Gaining Traction?

Inventories of new homes for sale continued to decline, falling 1.4% on the month and down 25.0% from a year ago. That combined with the higher sales rate drove the months of supply down to 7.6 months. That is still too high to indicate a healthy market (under six months), but is a major improvement from the 9.6 months in May and better than the 8.5 month level of a year ago.

We almost got to that healthy level in April as sales were boosted due to the end of the homebuyer tax credit, getting down to 6.1 months. Part of the better sales in June came from lower prices and sales at the lower end of the market. The average price of a new home dropped to $242,900 from $269,400 in May and $274,800 a year ago.

As the graph below (from http://www.calculatedriskblog.com/) shows, new home sales normally rise sharply towards the end of recessions, and are one of the most important locomotives pulling the economy out of recessions. This time around, the locomotive is derailed.

Except for May, the June level of new home sales would have been the lowest on record, and the records go all the way back to the Kennedy administration. They are also 76.2% below the peak set in July 2005 at the height of the bubble. The previous record low (prior to the Great Recession) was set in September 1981, back when mortgage rates were in the high teens, whereas in June, the average rate for a 30-year fixed mortgage was just 4.74%.

New Home Sales Crucial to Economy

Each new home built generates a huge amount of economic activity, and if new homes are not being sold, builders will not build since the cost of holding the inventory is very high. New home sales are thus much more important than existing home sales in terms of the health of the economy. Building new homes generates a lot of employment, and generally they are good-paying jobs for those without a lot of formal education.

The construction industry has been particularly hard-hit in this downturn, accounting for more than one in four jobs lost, even though at the start of the recession, it accounted for less than 6% of all the jobs in the country. Of course, high levels of unemployment is one of the reasons that demand for housing is so low. If you don’t have a job, or fear that you will lose your job in the near future, you don’t go out and buy a new home. High unemployment keeps the rate of household formation down. In other words, if Junior can’t get a job after he graduates, he stays living in Mom and Dad’s home.

However, the economic effects of new home construction and sales go far beyond just jobs for carpenters and electricians. New home sales generate demand for lumber, thus helping out firms like Plum Creek Timber (PCL). Makers of plumbing fixtures like Masco (MAS) are also very dependent on new home construction, as is wallboard maker USG (USG).

Even Berkshire Hathaway (BRK.B) is affected by the level of housing construction activity. Thus it is not just the homebuilders like Beazer Homes (BZH) and Lennar (LEN) that new home sales are important to, but the effects reach far and wide through the economy.

The one in four jobs lost only counts the direct construction workers, not the lumberjacks who have been laid off, or the workers at the plants that make building materials. Then consider that if the construction workers had jobs, they would be much more likely to take their families out to eat, thus stimulating employment of busboys, waiters and cooks. Oh, and construction jobs cannot be easily shipped to China or India.

Residential Investment Holding Back

The lack of push from residential investment is probably the single-most important reason that the economic recovery has been so anemic. Eventually, new home sale will rebound. After all, the population grows at about 1% per year. More people should mean greater need for places for people to live. As we saw in June, one does not have to make very heroic assumptions about the level of new home sales to generate some very impressive percentage gains.

On the other hand, with one out of every four homes with mortgages now underwater, there is a huge shadow inventory of existing homes. Being underwater on the mortgage is one of the best indicators of future foreclosures. If a home is worth more than the mortgage on it, in theory the level of foreclosures should be zero. It is always better to sell the house and get something rather than let the bank take it and get nothing, regardless of how bad the homeowner’s cash flow situation is. And existing homes are very good substitutes for new homes. 

The rebound in new home sales is less than meets the eye, even though they came in higher than the expected level of 310,000. That beat was more than offset by the downward revision to the May numbers. While eventually new home sales will recover simply from the pressure of built up demand, and when that happens the economy will start doing much better, it does not look like that is going to happen anytime in the immediate future.

If we are not going to get the demand from residential investment to power a recovery, then it becomes even more important that the demand come from somewhere else. Consumer demand is not growing due to 9.5% unemployment (and people dropping out of the labor force) and very slow increases in wage and salary income.

Business income is doing great, with profits up over 40% among the S&P 500 firms that have already reported. However, with manufacturing capacity utilization at only 71.4%, they are not about to go on a spending spree to buy more capacity. They are just sitting on the cash. If they paid out more in dividends, that might help boost overall consumer demand, although stock market wealth is very concentrated, and higher dividends are not going to help out the vast majority of Americans very much. Share repurchases, which in some ways are the economic equivalent of dividends, would not help as much since people are more likely to spend out of dividend income than sell shares that have gone up due to repurchase activity.

The Only Plausible Answer

The only real plausible answer to boost demand is more fiscal stimulus. Easier monetary policy would help a little bit, but the Fed has already used up most of its ammo. With no inflation around, indeed a much bigger risk of deflation than runaway inflation, the cost of the Fed pursuing an easier policy would be low. However, they are up against the zero bound, and even long-term rates are at historical lows, so the Fed can only help at the margin.

Real help will require Congress to get over its current obsession with the short-term budget deficit and do things like spend money to upgrade the nation’s deteriorating infrastructure and help out strapped state and local governments. The long-term structural deficits do need to be addressed, but mostly that means bending the cost curve on health care costs and letting the Bush tax cuts on the rich expire. Less spending on the Pentagon would also help reduce the structural deficit. However, in the short term, we need to run deficits.

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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