Demand

As we enter the summer of 2009 there are numerous signs around the world that the economy is improving. Of course, having gone down as far as we did, signs of recovery don't mean we are going to return to a booming economy instantly. They simply indicate that we have probably reached the bottom of the down cycle and have corrected those areas of the economy that were overheated, in this case primarily the real estate market.

Since the real estate market was the prime cause of the downturn many think it has to be the area that leads the recovery. I do think that stabilization of home prices is an important component, but I don't think that anyone should expect real estate to return to prior levels anytime soon. There has been a rather dramatic shift in the view of real estate by many people and it is no longer viewed as a "safe" investment. I would think we may see a rather long term if not permanent decline in home ownership. This will mean that the current inventory of housing may be adequate to meet demand for a good many years.

So lets consider what that means. People who will continue to own real estate will for the most part be those who either already own, or people with very good credit considering the new attitudes among lenders. However, many of the houses on the market may very well be purchased by speculators or investors and turned into rental units. In the later case, they of course will have to assure that the rental income provides enough of a return to justify the investment. They will be buying housing therefore at the cheapest possible price, including foreclosures, potential foreclosures and fix me ups in order to maximise returns. Regardless, they will have to fix up housing to make it rentable, with subsequent contractor employment.

So if you follow this logic, many marginal prior homeowners will become renters. I see two consequences of this. In many cases they will no longer have the increasing equity to tap that much of America has relied on. This will mean that they will have to use traditional credit or buy things with savings. In fact the biggest consequence I see for the economy of the next few years is this lack of equity, both for renters, obviously, but also for existing home owners. I don't see houses increasing in value nearly as rapidly as they did during the bubble. This may very well be a fairly permanent loss of demand in the economy that we need to consider. It is very hard for most people to obtain the same levels of credit they used to be able to when housing was higher priced, if they even want to. Without those levels of credit, they will not be able to return to prior levels of consumption.

Once again, if you accept this, it will be years before consumer demand returns to anything like the prior levels. A while ago, I posted some information about discretionary income. It has been very stable over the period we are discussing with increases related to stimulus payments and decreases right after to return to normal levels. However, the tremendous decrease in available credit, related to equity and stricter credit requirements has had the devastating impact we see. So unless there is a new sudden source of ready credit, we are going to see a fairly long term decrease in demand, although it should rise over time. So companies need to gear up for a long term decrease in domestic demand and see potential increases in demand in developing countries.