Scott Wren: Housing a Headwind at Least Through 2011

Includes: IYR, SPY
by: Harlan Levy

Scott L. Wren is a senior equity strategist with Wachovia Securities. Previously he was Senior Equity Strategist with A.G Edwards. He is often quoted in The Chicago Tribune, Los Angeles Times, Washington Post, and Wall Street Journal.

H.L.: What’s your outlook on the U.S. economy in light of the latest jumble of economic data: a smaller-than-expected 54,000 decline in August’s nonfarm jobs, a stronger-than-expected 67,000 increase in August’s private payrolls, weaker-than-expected August services data, and the anemic 1.6 percent growth in the second quarter’s Gross Domestic Product?

S.W.: I think that the slow, sluggish nature of this particular recovery is going to continue to be the case.

In all likelihood, the employment market will continue to slowly improve. However, as far as the unemployment rate goes, it might tick a little bit higher before it starts down in a more sustained fashion. We had felt that the unemployment rate would be 9.5 percent at the end of this year, but it may be a little bit higher than that: closer to 9.8.

What we’ve seen in the Institute for Supply Management reports is that overall the economy is expanding, but it’s expanding at a modest pace. With services accounting for 85 or 90 percent of the economy, and with the services output number weaker than what the market was looking for at just over 50 and just barely in expansionary territory, it means that the economy is growing at a modest rate. All that does is confirm the numbers we’ve seen lately, whether it’s auto sales, employment, or industrial production.

It’s all pointing toward the fact that we’re in the middle of a soft patch. It will probably last a few more months or a quarter or two, but our outlook is still for modest growth with modest inflation, as we move through 2011. l just don’t think you can get excited about the economy until maybe the second half of 2011 as we go into 2012.

H.L.: Do you see a double dip back into recession?

S.W.: We do not. We had felt that we had a 20 percent chance of a double-dip recession. We still think there’s a 20 percent chance, but we don’t think there will be a double-dip recession.

H.L.: The jobs picture remains weak. When do you think we’ll actually be able to add 150,000 jobs a month, the level to match population growth?

S.W.: Consistently? In 2011 probably in the second half we’ll see numbers in the 150,000 to 200,000 range.

H.L.: Will the housing situation drag on for more than a year, and if so, how much will it undercut any recovery that we’ll have?

S.W.: Housing is going to continue to be a headwind for the economy through at least 2011, and I think we have a reasonable probability of another leg down in terms of housing prices. The housing market is in a multi-year recovery process, and we’re in the bottom right now. It’s going to take a while. The housing market is not going to be much better in a year or two than what it is right now.

H.L: Standard & Poor’s predicts that "equity prices will gradually work their way higher in the coming year as sluggish U.S. economic growth, combined with the avoidance of a double-dip recession, allows bond yields to rise as the U.S economy moves further from the deflationary precipice." S&P also raise its 12-month S&P 500 target price from 1,190 to 1,200. What do you think?

S.W.: Our year-end target for the S&P 500 is 1100 to 1,140. We’re basically right at the bottom over that range right now, so we’re not expecting much upside. If we look out into the middle of 2011, we think the market will be somewhere in the 1,200 to 1,220 range, which is about 10- percent higher. But between now and the end of the year the S&P 500 is not going to do much.

H.L.: Are we in for deflation?

S.W: Our work would suggest that it will be minor inflation rather than deflation.

H.L.: Can the Federal Reserve do much to cure our economic doldrums?

S.W.: I think right now while the Fed may say they have lots of things they can do to help the economy, a further quantitative easing won’t have a great effect on the economy. Interest rates are low enough. Banks have lots of cash. There’s lots of liquidity out there in the system, but the demand for credit, whether it’s from businesses or consumers, is very low. I see further quantitative easing as the classic pushing on a string. I don’t think it will help. The Fed has its hands tied here.

H.L.: What must Congress do?

S.W.: To get the economy going, personally I like the idea of a payroll tax holiday. I think you need to put money in people’s hands. All the credits and other kinds of stuff haven’t worked too well. Trying to have the consumer pull the economy out of the doldrums by themselves is a stretch. The consumers are hesitant to spend. They’re in the middle of deleveraging. They want to pay down their own debt, so trying to boost the economy by trying to get people to borrow and spend money won’t work this time.

What the government needs to try to do is create an environment that is good for business and investment. Businesses right now are worried about their taxes. They know they will be going up. Also, they don’t know what these healthcare mandates will cost, and they don’t have a lot of demand coming from the consumer. They’ve got a lot of problems, and much of it is uncertainty by lack of a clear government policy.

This is going to take time. This recovery is going to take time. There’s no doubt about it. The government and the Fed will have trouble juicing this recovery. They’ve had luck doing it in the past, but we’re in a different situation now. Consumers are hesitant to take the lead here, and that won’t change any time soon . There’s a new mentality out there that we want to pay down debt, and we want to save. I hope that’s the case.

Disclosure: No positions