by Calculated Risk on 2/22/2012 11:54:00 AM

First a comment from Michelle Meyer and Ethan Harris at Merrill Lynch:

One of the most encouraging aspects of the report was the continued drop in inventory. The number of homes on the market for sale fell further in January after plunging 11.5% in December. This has left inventory almost 21% below the level last January. Combined with the recent gain in home sales, months supply has tumbled to 6.1 months, the lowest since April 2006. However, we expect this to be a temporary cyclical low. Part of the drop in inventory reflects delays in the foreclosure process which has slowed the flow of distressed properties into the market. We think the foreclosure process will accelerate, which will speed up the flow of distressed inventory. We expect supply to edge back to 8 months this year.

The NAR reported inventory fell to 2.31 million in January. This is down 20.6% from January 2011, and this is about 8% above the inventory level in January 2005 (mid-2005 was when inventory started increasing sharply). This decline in inventory was a significant story in 2011.

The following graph shows inventory by month since 2004. In 2005 (dark blue columns), inventory kept rising all year - and that was a clear sign that the housing bubble was ending.

Click on graph for larger image.

This year (dark red for January) inventory is at the lowest level for a January since 2005. Inventory is still elevated - especially with the much lower sales rate - but lower inventory levels put less downward pressure on house prices (of course the level of distressed properties is still very high, and there is a significant shadow inventory).

Part of the reason inventory has fallen is because there are fewer foreclosures listed for sale. Merrill Lynch analysts think supply will edge back up to 8 months-of-supply as the lenders increase foreclosure activity.

There is also a seasonal pattern. Inventory usually starts increasing in February and March, and peaks in July and August. The seasonal increase in inventory will be something to watch this spring and summer, but the Merrill forecast would mean that inventory increases to over 3 million units this summer (assuming sales at the current rate). I don't think we will see inventory that high.

The following graph shows existing home sales Not Seasonally Adjusted (NSA).

Sales NSA (red column) are slightly above the sales for the last four years (2008 through 2011), but well below the bubble years of 2005 and 2006.

The level of sales is still elevated due to investor buying. The NAR noted:

All-cash sales were unchanged at 31 percent in January; they were 32 percent in January 2011. Investors account for the bulk of cash transactions.

Investors purchased 23 percent of homes in January, up from 21 percent in December; they were 23 percent in January 2011.

Earlier:
• Existing Home Sales in January: 4.57 million SAAR, 6.1 months of supply
• Existing Home Sales graphs