House Prices, Bonds, and Investors

Two very interesting bits of news to share with you, each alarming for the economy and American consumers:

Yesterday, the U.S. Commerce Department released this very important news about home construction. New home construction in the U.S. declined 6% in August to its lowest level since April, 2003. Housing starts are now down 20% from a year ago.

On Monday, a group of economists from Merrill Lynch & Co. said they expect house prices in the U.S. to actually decline 5% in 2007.

If U.S. home starts continue to decline, we will soon start to see layoffs in the construction sector, the ramifications of which are obvious to the U.S. economy. I see a few economists now coming out and raising their bets on a U.S. recession next year. Any way you look at it, the Fed will have to start lowering interest rates to fend off the hard landing in the housing market and to keep the economy out of recession’s way. Bonds, which I recommended months ago, are still the place to be.

If Merrill Lynch is right, and housing prices in the U.S. actually do decline an average of 5% next year, the impact on the U.S. economy could potentially be greater than anyone can fathom at this time. While this may not be you, imagine the poor home owner who put 10% down to buy last year. By next year, 50% of their equity would be wiped out. If they bought with an adjustable rate (“buy now, pay me later”) mortgage, they are in double trouble.

I continue to be very bearish on the U.S. housing market–I believe it has the potential to take down the U.S. economy next year. Always looking for a positive in a negative, I see bonds as the only avenue for investors looking for upside. I believe interest rates in the U.S. could actually plummet, which would obviously have a huge impact on the prices of good quality bonds. Bonds might not be too exciting, but they sure may prove to a safe place to be in the short-term.