Read the tea leaves. Throw the bones. Gaze into the crystal ball. Consult the oracle of your choice. We've always been fascinated by the future. That, after all, is where our fortunes lie.
Although leaps in technology have improved our powers of prognostication, the future remains unknown and unknowable. There will always be the unexpected: terrorist attacks, oil crises, natural disasters, blackouts.
Barring the unexpected, 2004 looks like a very good year for the U.S. economy. There's solid consensus among economists that real GDP growth began accelerating this year and that the growth will continue in the strong, but more modest and sustainable 4-percent range in 2003. Most anticipate that inflation will remain low, likely drifting higher, maybe lower, but not likely to fall into a dangerous deflationary trend. Federal spending and tax cuts will continue to pump money into the economy, spurring both consumer and business spending.
Short-term interest rates will remain low as the Federal Reserve maintains its expansionary monetary policy. Mortgage rates probably won't approach this year's low. They'll rise, but modestly, with probably only a small impact on home sales. Household income will continue to rise and job creation will finally kick in with enough strength to nudge the unemployment rate down, economists forecast.
Economists say they expect similar conditions in 2005 and a healthy economic environment through the next decade. The U.S. Blue Chip Consensus is for 3.3 percent real GDP growth in 2005, followed by five years averaging 3.2 percent and another five years averaging 3.1 percent. This is in line with what some economists consider the "natural" growth rate of the U.S. economy.
The Blue Chip Consensus is for the unemployment rate slowly to drift down throughout the next decade, from 5.6 percent in 2005 to an average 5.3 percent through 2009 and 5.2 percent in the following five years. Since the U.S. population will be growing at about 1 percent a year, the modest change in the unemployment rate represents a significant number of new jobs. Disposable personal income is forecast to grow at about the same rate as GDP, while the consumer price index remains comfortably below GDP growth, at 2.3 percent in 2005, drifting up to 2.5 percent, on average, in the second half of the decade.
Not surprisingly, Bush Administration forecasts for the next several years are slightly higher for GDP growth and slightly lower for a rise in the consumer price index.
Of course, all long-term projections must be taken with a grain of salt. Uncertainties multiply fast. They can lead to unforeseen obstacles to growth or prove economists too conservative in their outlook, even in the short term.
"One of the major uncertainties in all this forecasting is in population and household growth," explains NAHB chief economist David Seiders, "and it has to do with immigration. We've been working from the middle series of the Census Bureau projections. But we may be on a higher growth track next year if immigration flow is a lot stronger than we are assuming. Housing next year need not fall off. It's such an imponderable, we don't know what to do with it."
Whether housing is great in 2004 or just very good remains to be seen. Builders may find it hard to view 2004 objectively after this year's record-breaking performance.
New single-family home sales hit an all-time, seasonably adjusted rate of 1.18 million units in June, and it seems all but certain that total new home sales will top the million-unit mark for the first time by year's end. Roaring through months of accelerating growth, housing starts hit a seasonably adjusted rate of 1.89 million units in July, the fastest pace in 25 years. September nearly equaled the record with 1.88 million starts. Housing permits hovered in the 1.42 million-unit range through mid-year, suggesting continued strong housing activity well into 2004. In October, consumer confidence rose with a brightening job market, and builder confidence in the single-family home market surged to its highest level since December 1999.
In spite of a stronger economy, or because of it, housing may not fare as well in 2004.
"We're coming off what is turning out to be a huge 2003 with what feels like some unsustainable bulges in it," says Seiders. "This year is on track to exceed one million sales for the first time and I'm forecasting 1.43 million single-family starts." But his forecast for next year is more modest: single-family starts down 5 percent to 1.36 million units, "which is still excellent," he adds, with sales of 980,000 units, which would make 2004 the second-best year on record. Seiders ascribes the modest declines to "some upper interest rate pressure and the feeling that we've yanked a bit of demand forward."
Mortgage rates in the 6-percent to low 7-percent range "shouldn't put a huge damper on housing as long as the reason rates are going up is that the economy is growing," says David Berson, Fannie Mae chief economist. Historically, periods in which interest rates were going up because the economy grew, and not because there was a supply shock, were years in which the housing market expanded, not contracted," he says.
Long-term rates in the 6.5-percent range may represent little real change, explains Doug Duncan, senior vice president and chief economist for the Mortgage Bankers Association of America. "Real interest rates might be rising, but the rate of inflation is still likely to be falling, which means on balance there's not a lot of movement on rates," he says.
Home buyers all but abandoned adjustable rate mortgages (ARMs) in 2003's bargain basement rate environment. But with interest rates rising even modestly, more buyers are likely to use ARMs next year to stay in the market, which should help maintain first-time buyer demand.
"With the Fed holding the very short end of the rate structure steady until the middle of next year, I think we're looking at one-year ARMs below 4 percent through that period with some increases later, but probably not dramatic increases," Seiders says.
Anticipating a "fairly steady interest rate environment" and more job creation, Jim Wilson, managing director and director or research for business and housing services for JMP Partners, a San Francisco-based investment bank, says housing could be "a little higher" in 2004, even with higher mortgage rates. "Normally coming out of an economic downturn, job creation outweighs interest rate issues," he says. "That should help so that [housing activity] can still be somewhere around this year's level. I don't think being a little lower or a little higher will make a whole lot of difference," he adds.
Lynn Reaser, chief economist for Banc of America Capital Management, also says she expects builder activity to stay at a healthy level in 2004, with mortgage rates moderate and plenty of financing available from banks. Thirty-year mortgage rates at 6.5 percent to 7 percent, "won't be an impediment to the housing market. In some markets we may see small declines and in others small increases, but generally the market will level off," Reaser adds. Volume will be good, but home builders "won't have the kinds of gains we've seen earlier in the expansion," she says.
Total housing starts are forecast to decline slightly, according to Frank Nothaft, a Freddie Mac chief economist. "We estimate that single [family] and multifamily starts will total 1.74 million units this year and we see a decline of about 80,000 units in 2004," he says. In the same period, he says he expects the rise in home prices to moderate, appreciating around 4.5 percent following an increase of 5 percent this year.
Wildcard in Jobs
Joe Sroka, equity research analyst for Merrill Lynch, says he expects the level of housing activity to be similar to this year. "As you see some pick-up in the economy, there is certainly going to be a tradeoff between interest rates and employment activity," he says. "That's been the offset for the last two years that has kept the housing market running smoothly. As unemployment moved up, that movement was counterbalanced by lower mortgage rates."
That tradeoff will remain in place, Sroka says, and "what that means to us is that maybe housing changes by some single-digit percentage, either up or down. But what's important is that it won't change by a double-digit percentage."
In fact, small versus large variations in the market are positive for big builders, Sroka says. The large builders are growing faster than the market because they are gaining market share. And when the market is changing by a small percentage, "then within that mild degree of cyclicality, the market share you are gaining as a big builder has a big impact on your earnings," Sroka explains. Big builders should have a very good year in 2004, he says, mainly driven by those market share gains.
The wild card in just about every forecaster's deck is job creation. If sufficient jobs are created to affect the unemployment rate, the economy will ratchet up accordingly, economists say, perpetuating a positive cycle. Insufficient job creation, on the other hand, could sustain a continuation of a lackluster recovery.
"Obviously, the lack of job creation is an area of concern," says Lawrence Yun, senior economist with the National Association of Realtors. "It is a key factor in our forecast. In 2002 the economy grew 2.5 percent, and 2003 is a similar story, so we are producing more but with fewer people. We anticipate some turnaround in the job market, but if it doesn't pan out, then the whole story of income growth and consumer spending may not be realized as we anticipate," he says.
"With a GDP growth rate of 4 percent, next year will be the strongest year in about four years," says Nothaft, "and that's sufficient to generate job creation. We'll start to see the unemployment rate gradually start coming down, ending the year around 5.5 percent," he says.
Whether early or late, economists and analysts say, job growth will click in and further strengthen the framework for recovery into 2005 and beyond. "Unless the economic equation has changed so incredibly that we just can't understand it, I think that the emergence of decent job growth is basically inevitable. It's the timing that is uncertain," Seiders says. Overall, economists are anticipating several years of economic growth.
"I don't think we will fall back in 2005, but rather settle down to somewhat slower GDP growth rates, but that is natural" says Seiders. Several years of below trend growth have eroded the labor market, he says. Now we need a couple of years of above trend growth to "bring the labor market back to equilibrium." That's an unemployment rate around 5.2 percent, he says. "I think by 2005 we are moving right around that number and the GDP rates are correspondingly receding from the 4 percent to 5 percent range back to somewhere around 3 percent," he adds.
Nothaft sees the economy expanding in 2005, but, "a little weaker than 2004, around 3.5 percent." This "very solid number" will continue to cut unemployment to the low 5-percent range by the end of 2005. "And we see house price growth settling in at 3 percent to 5 percent annually for the balance of the decade," he adds.
The forecast beyond 2004 is for continued economic strengthening and growth, according to Duncan. "We see the Fed moving to a more neutral position and raising short-term rates so that by the end of 2005, the federal funds rate will be in the 4-percent to 4.5-percent range. But at that point we still don't see mortgage rates being above 7 percent or 7.5 percent," he says.
Even with favorable mortgage rates, housing will decline somewhat, he adds. "We will see a little more of a drop in new home sales in 2005, maybe 3 percent to 4 percent from the 2004 level, which would be about 5 percent less than this year. But we are talking about a return to levels comparable to 2001, a record at the time." Those in the market will have to "retain a historical perspective" in order not to overreact to the decline, adds Duncan.
"This is a sustainable expansion," says Reaser. She points to strong and continuing productivity gains, favorable demographics, technologies that "seem on the threshold of significant new innovations, industries, and markets," and expanding overseas markets at wealth develops in Asia and other areas of the world. The gains in productivity suggest that the U.S. economy is currently growing by 3 percent to 3.5 percent, she says. "That's our natural tendency, which means that outside of shocks to the economy, we should return to that track," she explains.
Another terrorist attack on U.S. soil might shock the economy, or turmoil in the Middle East and the world oil market. "On the downside, almost all the considerations are international," Duncan says. "A major terrorist attack again would throw a lot of uncertainty into the market." Our economy is funded by global capital markets, he adds. Conflicts in trade and the free flow of capital and goods "could do significant damage to the dollar and exchange rates and alter the flow of capital into the U.S.," which would drive up interest rates.
On the other hand, the world economy is synchronized and could grow too fast, Berson explains, pulling prices and interest rates up. "It would be a negative for the U.S. economy and a larger negative for the housing market," he says.
But the U.S. economy has become more self-regulating as it has grown, some economists say, and is therefore less susceptible to large changes up or down.
"Even after the shock of 9/11, the economy regulated itself. Interest rates came down to create liquidity in the economy to offset that system shock," Sroka says. Looking forward, "Housing won't be any more cyclical than the economy and I think the economy has become a bit less cyclical," he adds.
Economist and analysts have crunched the numbers, studied trends, consulted their mathematical models. To a large degree they see solid, sustainable growth for the U.S. economy for several years ahead and the housing market on a sure, but perhaps more modest, footing at least throughout the decade. But what actually will happen in 2004 and beyond is anybody's guess.