Will the housing bust lead to a Recession?

So many reports on the poor state of the US Housing Market. And today, I noted this article posted on yahoo ( here ) and the biggest concern is will the US housing bust lead to a Recession?

Real Estate

Can the Economy Survive the Housing Bust?

Fortune on CNNMoney.com
By Jon Birger

Real estate downturns have a way of leading to recessions and stock market slumps. So far the damage has been limited, but the numbers keep getting worse, says Fortune's Jon Birger.

Tucked away in the briefcase of Liz Ann Sonders, chief investment strategist at Charles Schwab & Co., is a chart so scary she's hesitant to show it to investors. It plots the National Association of Home Builders' Housing Market index - a monthly measure of builder confidence - against the Standard & Poor's 500 stock market index, with a one-year lag.

It turns out that the mood of builders is a terrific stock market bellwether: The correlation between current builder confidence and future stock market returns over the past ten years is downright unnerving.

Not only did the NAHB index presage the start of the post-1994 bull market in stocks, but its decline starting in 1999 foreshadowed the equity market collapse that came the following year. Builder confidence rebounded in November 2001 - a year ahead of the stock market upswing that began in October 2002.

Why is Sonders worried now? Just look at the chart. Over the past year, the NAHB housing index plummeted 54 percent. Were stocks to follow suit, the S&P - 1400 in late October - would be trading below 700 this time next year.

Sonders isn't predicting anything so apocalyptic, but she doesn't hide her concern about housing and her pessimism about stocks.

"In terms of consumer spending, I don't think we've felt anywhere near the brunt of all the adjustable-rate-mortgage resets and the massive increase in defaults and foreclosures in states like California," she says. "Housing downturns happen in a fairly slow-motion way, and I really think we're just at the beginning of the impact on the market and the economy."

The latest omen: GDP grew at its slowest pace in three years in the third quarter, hurt by the housing slump.

Such bearishness flies in the face of the euphoria now rampant on Wall Street. The Dow Jones industrial average keeps hitting new highs, and the S&P is a stone's throw away from its own record (although in inflation-adjusted terms, they're still below their peaks).

Third-quarter earnings? One report seems better than the next, with key companies like Google (92 percent profit growth), IBM (54 percent), and Bank of America (41 percent) all posting stellar numbers.

"The effects of the housing correction will be entirely contained within the housing sector," says Mike Englund, chief economist of Action Economics. Corporate balance sheets are stronger than they've been in years, with U.S. companies sitting on $600 billion in cash. Interest rates are stable, and may decline. Falling energy prices are easing the burden on energy-intensive industries like chemicals and airlines.

And as PNC chief investment strategist Jeff Kleintop points out, there have been only two midterm election years since World War II when the stock market did not stage a fourth-quarter rally. The bulls' bottom line: Housing may be a risk factor, but there's too much other good news for it to be the catalyst for a recession or stock market meltdown.

That may turn out to be wishful thinking. All the economic activity generated by home sales - new mortgages, realtor fees, outlays to painters and handymen, the inevitable shopping trips to Home Depot and Best Buy - played a huge part in digging the economy out of a recession in 2001 and 2002. Given the importance of home sales on the way up, it may be shortsighted to minimize their importance on the way down.

"The historical record is extremely negative in terms of what comes next," says economist Ed Leamer, director of the UCLA Anderson Forecast. "We've had 11 sharp declines in the housing market since World War II, including this one. Eight of the last ten were followed by a recession."

For now, there's little hard evidence that the housing slowdown is dragging down the economy. Construction materials like concrete, wallboard and structural steel should be the canaries in the economic coal mine, yet their prices keep climbing.