Montreal, Canada

The prospect for a quick residential real estate recovery continues to look dim in 2009 as the market struggles to wind down a 12-month supply glut.

Recent housing data point to a gradual improvement in some areas of the battered U.S. real estate market. To be sure, existing house sales have edged higher this spring and prices in some regions have begun to stabilize. But we’re still a long way off from a new bull market – probably years away as a lethal combination of rising unemployment, soaring foreclosures, ARM resets and a supply glut weigh on recovery prospects.

U.S. home prices eased their dizzy slide in April, according to the latest report by the Standard & Poor’s/Case-Shiller Index. Thirteen cities reported price gains in April as Dallas, Denver and Cleveland led the way with a 1% gain compared to a month earlier.

But the big picture for this index continues to look grim with home prices down 18% compared to 12 months ago and almost 33% off their all-time high in mid-2006.

Unlike previous bear markets in housing – most recently in the late 1980s – this recession is unique because of the extent of damage inflicted by a crash in credit, leveraged borrowing and domestic consumption since 2008. A sharp recovery is almost impossible over the next few years because employment trends remain dire and consumer confidence is near a multi-decade low; more importantly, there’s a huge overhang of unsold homes or too much inventory that will take years to wind down.

Probably the most worrisome short-term concern for residential housing is the surge in U.S. foreclosures recently coupled by a plunge in refinancing activity. The Fed’s ambitious plans to purchase up to $300 billion dollars’ worth of mortgage-backed securities since last November has failed to contain long-term fixed-rate mortgages this year. The recent spike in mortgage rates – though moderating since late June – remains elevated in a market that’s still lacking credit. Many jumbo mortgages are also being turned down as banks refrain from real estate lending in a declining market.

I’ve argued all along this year that we are in the midst of a long recovery process whereby credit markets are still largely dysfunctional and still dependent on Federal Reserve intervention to an extent. Interest rates are indeed super low but they’re also at these levels for a good reason. The demand for credit or funds is anemic and banks are still hoarding cash.

The stock market rally is now overdone because corporate earnings won’t recover beyond this fall, if at all. Basically, the government is providing a huge slop of short-term credit financing that’s ballooning asset values over the last three months. Worse, near zero percent interest rates is forcing depositors and other conservative investors back into the market because they’re desperate for yield. To interpret this economic recovery as a typical post-WW II expansion is dangerously futile. At some point over the next 6-12 months I suspect Mr. Market will need another injection of government stimulus and that’s when we’ll take-out the March 9 lows.

The majority of investors, traders and money-managers continue to underestimate a credit depression. Nobody alive has ever witnessed such a monster collapse of credit values. To believe that we’re on the road to riches again is just nonsense.

For now, the trend is your friend.