MARKET RECAP

Sometimes bad news isn't as bad as it seems. For instance, gross domestic product dropped at a 6.1% annual pace in the first quarter of 2009, easily blowing past predictions for a 5% annualized drop. The decrease marked the weakest posting since 1958. Bad news, right?

Not so fast. It's tempting to cite the grim first-quarter GDP decline to squelch talk of any recovery in the U.S. economy, but the numbers actually contain flickers of hope. Nearly half of the GDP contraction was due to businesses slashing production in order to bring inventories in line with sales. The process, although perhaps incomplete, is well advanced, which means businesses may soon have production levels where they want them. That, in turn, could set the stage for increased business spending in the second half of the year as consumer demand increases.

In fact, consumer demand is already picking up. The monthly data on home, car, and retail sales confirm that consumption has broadly stabilized. Although home construction has tumbled, the worst is probably over: in any case, the sector is now so small that further declines mean little to overall output. The recent rise in stocks prices – arguably the most reliable economic indicator – and in consumer confidence also bodes well for businesses and consumers alike

More good news can be found in seemingly bad news on the housing front. Home prices continued to decline in 20 major U.S. cities in February, according to the S&P/Case-Shiller Home Price Index, but the rate of decrease slowed for the first time since 2007. Average prices are now down 30.7% from the housing market's mid-2006 peak. Phoenix has fallen the furthest, dropping 50.8% from its high, while Dallas has been one of the better performers, slipping a relatively modest 11.1% from its peak. Odds at this juncture favor long-term home-price appreciation over long-term depreciation.

Meanwhile, mortgage rates continue to hold steady, with 30-year fixed-rate mortgages still available in the 5% range. But again, we need to warn that rates could be approaching a low, if they haven't already reached one. Treasury yields are starting to rise, a sign of a strengthening economy and a sign that inflation could be lurking on the horizon. At this point, we think holding out for lower mortgage rates is becoming a riskier bet.

Averages are an intricate part of data aggregation and dissemination. We reference averages, such as national average mortgage rates or average existing new or existing home prices, in the newsletter. These averages are useful, because they project a large macroeconomic picture quickly.

But averages can also misinform. Picture a room with Bill Gates, Warren Buffett, and eight other people, each of whom earn $100,000 annually. If a statistician were to average the annual incomes of the 10 inhabitants, the average annual income would be several million dollars a year, even though eight of the 10 inhabitants make nowhere near that amount. It would be impossible to implement a successful sales strategy based on that average income. In other words, averages can be irrelevant.

Such is often the case with real estate. We noted that home prices in Phoenix tumbled an average of 51% from 2006 highs, while Dallas prices tumbled an average of 11%. Average these two numbers and you get an average decline of 31%, which makes the Phoenix market look more robust than it is and the Dallas market less robust. What's more, that average is even more misleading because it is based on an average of an average.

Point is, don't let national averages influence your opinion of the economy too much. Most business is local, and what's happening in one part of the country can be completely different from what is happening in another part of the country. What's happening in your part of the country is what's most relevant.

Politicians of all stripes have lamented that the bursting of the housing bubble has been a national tragedy. But is it really that bad? According to George Mason law professor Todd Zywicki, the answer is “no.” In a recent Forbes article, Zywicki reasons that there are three types of housing markets, and only one of the three shows real signs of distress.

Zywicki states that the first type of market behaves the way markets are supposed to behave, with smooth adjustments between supply and demand. When prices rose, builders constructed new houses. When prices softened, builders stopped. Charlotte and Dallas represent such markets. The second type of market demonstrates a long history of price volatility, such in San Francisco and Seattle . Zywicki notes that people who live in these markets expect big price swings and adjust their behavior accordingly. These two markets, says Zywicki, are basically sound.

The third type of market displays both the ability to expand the supply of houses that characterizes the first type of market and the price swings that characterize the second type. This is the market where the real bubble developed, and not surprisingly, it is concentrated in the Sun Belt: namely, Las Vegas , Tampa , and Phoenix . Investors seem to have calculated that a lot of people would either retire or buy second homes in these places. And when prices went up, speculators moved in and a bubble formed.

Zywicki might be on to something: If you vet the news carefully enough, you'll find more stories highlighting rebounds in many of the type one and two housing markets. Yes, troubles in the Sun Belt remain frustratingly intractable, but given current mortgage rates and the plethora of buyers' incentives, we suspect that market will recover sooner than many pundits think.

It's a homebuyer's market and a refinancing market – a keen observation of the obvious. But let's remember that rates can only go so low, and by historical levels they are darn low.

These low rates are actually frustrating at times, because we constantly hear from people who say they won't buy a home or refinance a mortgage until rates fall to 4%, or even lower. It's an irrational extrapolation. There's no evidence that rates will hit 4% anytime soon. To the contrary, the Federal Reserve has been furiously pumping dollars into the U.S. economy, raising the probability of higher interest rates down the road. But if rates do continue to slide, refinancing is always an option. In the meantime, why not take advantage of today's already historically low rates?

Let's also remember that buyers' markets don't last forever. The inventory of unsold homes still remains high, at least on a national level. The NAR reports that the number of unsold homes on the market represents 9.7 months' worth at the current sales pace. But change can occur remarkably fast. To wit: The California Association of Realtors said existing-home sales in the state were up 83% in February from the previous year, helping to shrink inventories to a six months' supply from 15 months. When the sales pace dips below five months, the tide starts to turn, favoring sellers over buyers.

We all want the best price, and it's tempting to hold out for that price, but trying to time a market bottom is a Quixotic endeavor – one that often costs much more than it saves.