Existing home sales rose 10.0% in September to an annual rate of 4.53 million from a slightly downwardly revised rate of 4.12 million in August. Relative to a year ago, sales are down 19.1%.

Existing home sales have been significantly distorted by the tax credit timing. A year ago, sales were starting to ramp up due to a tax credit that was supposed to end in November but was extended through April, with closing through the end of June. Since existing home sales are recorded at closing, many sales that would have normally occurred in July and August were pushed into June.

The September rise is a partial recovery from that hangover. The first graph below (from http://www.calculatedriskblog.com/) shows just how erratic existing home sales have been over the last 18 months.

The big peaks and valleys are due to the perceived availability of the tax credit (perceived since it was not expected that the tax credit would be extended, much less enhanced past November). While the rise from August levels is welcome, it is clear that in any absolute sense existing home sales remain very depressed.


 
However, the absolute level of existing home sales is not really that important. The reason for this is that they are already existing assets. As they change hands, relatively little economic activity is triggered. Oh, people do tend to redecorate a “new for them” house. That can help out paint companies like PPG Industries (PPG) and Sherwin Williams (SHW), and the level of sales obviously affects the incomes of realtors. But relative to the amount of economic activity generated by a new home sale, existing home sales are just not that important.

The Direction of Housing Value

What is important is the value of existing houses, and the direction the value is going. For the vast majority of people, their house is their single most-important asset, and is, or at least was, their most important store of wealth. While the total value of stock market wealth may be greater than that of housing wealth, stock market wealth is far more concentrated (very few people have eight figures worth of housing equity, while 8 and even 9 figure stock portfolios are relatively common).

Housing is also a far more leveraged asset, where one is being conservative if one puts 20% down, while putting 50% down on a stack market purchase is being very aggressive. While the median price is not the best measure, it does have the advantage of being relatively timely.

Case-Schiller Numbers Tomorrow

The gold standard of home price measurement is the Case-Schiller index which will be released tomorrow, but with data for August, and that is actually an average of June, July and August data. The news on the pricing front was not good, with the price of a median home falling 2.4% from a year ago to $171,700. With 23% of all homes with mortgages worth less than the amount of the mortgage, sinking home prices mean more homeowners are slipping underwater.

Being underwater is a necessary — but not sufficient — condition in which a foreclosure occurs. Combine it with lower cash flow (one or both breadwinners out of work, illness, divorce, etc.) and foreclosures become frequent events.

Inventory Levels

Looking forward, the news does not appear to get better. While the absolute level of inventories fell 1.9% to 4.04 million, that still represents 10.7 months of supply, down from 12.0 months in August. The second graph (also from  http://www.calculatedriskblog.com/) shows the history of the months of supply metric. This is what tends to determine the future direction of housing prices — good old supply and demand.

While nicely down from the worst of the July hangover, we remain at levels that are as bad as the worst of the housing collapse in 2008. Six months is about normal, and we were consistently well below that level during the housing bubble.

Fortunately, housing prices have already fallen and are now roughly in line with long-term historical norms relative to rents and incomes. Not particularly cheap on a historical basis, but no longer wildly overvalued either.

Mortgage rates are at historic lows, averaging just 4.35% in September, down from 4.43% in August and 5.06% a year ago. That will probably limit the degree of future price declines to less than 10%, rather than the almost 30% decline we have already seen from the bubble peaks.


 
Still, even small declines have the potential to inflict damage to the overall economy. Existing homes are pretty good substitutes for new homes, and as long as there is a big inventory overhang of existing homes, there is little need to build more new homes.

Not Out of the Woods

New homebuilding generates a huge amount of economic activity, and is historically been the starter engine for the economy. It just is not playing that role this time around, and is by far the biggest reason why this recovery has been so lethargic. Uncertainty over future taxes and regulations pale by comparison.

As prices decline, more homes slip underwater and become foreclosure-prone. Those that are already under water become further underwater, and the depth does matter. Few will resort to “jingle mail” if they are just $1,000 underwater (a house is, after all, a home, and noneconomic considerations matter a great deal). However, if someone is underwater by $100,000 then just walking away becomes an increasingly rational decision.

While it was nice to see existing home sales do better than expected (the consensus was at a 4.30 million rate), we are far from out of the woods on the housing front. The level of inventory relative to sales is still at scary levels that point to further drops in the value of homes. That destruction of wealth will force people to try to save even more. That, in turn, will act as a brake on the economy. The recovery in homebuilding will be delayed, that will also be a big drag on things.

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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