U.S. Markets open in 6 hrs

Economic optimism index falls again, negative for homebuilders

Brent Nyitray, Sr Real Estate Analyst

The Investor’s Business Daily/TechnoMetrica Optimism Index is considered to be a preview of the upcoming consumer confidence indices

The Investor’s Business Daily/TechnoMetrica Optimism Index (IBD/TIPP Index) has a good track record of predicting how the two major consumer confidence indices—the Conference Board and the University of Michigan Consumer Confidence indices—will look when they’re released later in the month. The IBD/TIPP Index is conducted from a poll of 901 adults in the last week of July.

(Read more: Bernanke’s comments send mortgage rates screaming higher)

The index has three major components: the six-month economic outlook, the six-month personal financial outlook, and confidence in federal policies.

Consumption is the major driver of the U.S. economy and accounts for 70% of GDP. Consumption has been relatively subdued since the recession began, as Americans have boosted their savings rate and spent only on essentials. The real estate bubble drove consumption in the mid ’00s as people took out cash refinances and spent the extracted home equity. This increased the cost basis for many people’s homes and left them vulnerable when house prices collapsed. As a result, they’ve focused more on paying down debt than on spending.

(Read more: Mortgage rates fall slightly)

Highlights from the report

The IBD/TIPP Optimism Index decreased by 2 points to 45.1 versus 47 in July. It’s just slightly below its 12-month average. A reading below 50 indicates pessimism, and a reading over 50 indicates a positive outlook, while a reading under 50 indicates a negative outlook.

The six-month economic outlook dropped 2.3 points to 45.8.

The personal financial outlook dropped 2.3 points to 53.8. Rising asset prices (particularly real estate and stock prices) contributed positively to the report.

Finally, confidence in the government fell again to 35.8. Overall, Americans have little faith in government.

A surprising statistic from the survey is that 56% of respondents think the United States is still in a recession. There continues to be a disconnect between the Fed-driven asset prices as measured by the S&P 500 and everyone else.

(Read more: Real Estate Price Appreciation widely dispersed by location)

Implications for homebuilders

Buying a home (particularly a new home) requires a great deal of confidence in the future. Indeed, KB Home (KBH) said that consumer confidence is even more important than interest rates. Homebuilders need consumers to be comfortable in their personal situation, the economy, and the future of home prices. The index shows that people are more confident in their own situation than they are in the economy in general.

For homebuilders, it pays to focus on the segments of the market that seem to have the most confidence, and that means people with appreciating homes and portfolios—the luxury and move-up buyers. The most obvious beneficiary of this dynamic would be Toll Brothers (TOL), which focuses on the luxury and move-up market. Its average sale price is $557,000. The other beneficiary would be NVR, which has an average selling price of $317,000, although NVR is exposed primarily to the East Coast. The East Coast has been lagging the West Coast in price appreciation, although some of the latest indices show that activity is starting to pick up while shortages are cooling off the West Coast. Meritage (MTH) is another builder focused on the move-up buyer. PulteGroup (PHM) and Beazer (BZH) both noted decreases in orders because the first-time homebuyer is put off by higher rates and home prices.

More From Market Realist