April 12, 2024

Housing Market Crash Alert: Should Investors Worry About Declining Home Prices?

A potential drop in home prices next year could pose challenges for the economic expansion

home prices - Housing Market Crash Alert: Should Investors Worry About Declining Home Prices?

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The U.S. economic expansion continues to look very strong, and it appears poised to continue along that path. Moreover, with inflation easing and the pivotal presidential election looming next year, I remain convinced the Federal Reserve will indeed meaningfully cut rates in 2024.

Still, the economy and stocks face multiple meaningful threats. Specifically, an upcoming decline in home prices may result in meaningfully weaker demand for products from many consumers and businesses while the reluctance of shipping firms to use the Suez Canal could cause inflation to reaccelerate.

The U.S. Economy Continues to Show Signs of Strength

In December, an index of consumer confidence came in at 110, well above economists’ average estimate of 104.5 and representing the index’s highest level in five months. Importantly, a component of the index “that looks at how consumers feel about the economy right now increased to 148.5 from 136.5 in the prior month.” Also noteworthy is weekly jobless claims stayed very low on a historical basis during the week of Dec. 20, while consumers’ spending last month rose a significant 0.2% above inflation compared to October. The latter increase was held down by a large decline in gasoline prices. Additionally, Americans’ incomes advanced a strong 0.4% in November versus the previous month.

Given all of those data points, I expect consumer spending to continue to grow meaningfully in the near and medium term.

Providing more evidence of the economy’s strength, durable goods orders jumped 5.4% in November. That was the biggest increase since July 2020. Finally, the Fed is now predicting that economic expansion for Q4 will come in at a robust, seasonally adjusted annualized rate of 2.3% above inflation for Q4.

Inflation Is Still Slowing and the Economy Is Becoming More Balanced

In November, the personal consumption expenditure price index, a measure of inflation closely watched by the Fed, fell 0.1% versus October. That was the first time the index dropped on a month-over-month basis in over three and a half years.

Meanwhile, earlier this month, before the latest reading of the PCE index was released, Goldman Sachs (NYSE:GS) Chief Economist Jan Hatzius said the U.S. had entered a period of “The Great Disinflation” that should enable the Fed to reduce rates three times “by summer.”

Indeed, as I pointed out in a previous column, I expect inflation to spiral downward by multiple factors in the coming months and years. And like Hatzius, I anticipate the Fed will cut rates multiple times in 2024. As I noted in my last piece, I believe the central bank’s desire to reduce rates is partly due to economic and partly spurred by political considerations.

There Are Potential Challenges Ahead

While interest rate cuts are positive for the economy as a whole in these very unusual times, the cuts may actually push housing prices way down. That’s because home prices have risen so rapidly in recent years, primarily because few consumers are selling their homes. And few consumers have been selling their homes mostly because interest rates have soared so quickly that anyone who moves to a new home would have to pay much higher rates than in their current home.

As a result, when mortgage rates come down, many homes are going to come on the market. While the demand for housing will also rise, I expect the increase of single-family homes for sale to meaningfully outpace the demand for such houses. That’s because a very high percentage of homeowners are senior citizens likely looking to buy condos or townhouses after selling their single-family homes.

A decline in home prices, in turn, may cause the growth of consumer spending to decelerate to some extent because homeowners will feel less wealthy after the value of their homes drops.

Moreover, a meaningful decline in home prices will likely negatively impact home builders, raw materials firms and realtors. Home builders’ profits will drop, causing them to pay less for raw materials, while realtors’ commissions will decline.

Moving to another threat to the economic expansion, the decision by some shippers to avoid using the Suez Canal could cause oil prices and goods prices to surge, spurring inflation to jump and forcing the Fed to refrain from cutting rates.

While I don’t expect these threats to wind up meaningfully hurting the economy and stocks, investors should certainly keep an eye on them and attempt to gauge their impact on the economy.

On the date of publication, Larry Ramer did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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