The 2006 Economy: Boom or Bust?

Dec. 30, 2005 — -- With 2006 right around the corner, what's the prognosis for the economy next year? Will there be a boom or bust in housing, jobs and the stock market? And is inflation going to take a bite out of your wallet?

"Good Morning America's" financial contributor Mellody Hobson gives her predictions for the coming year.

Housing Market: Bust

It looks like the housing market is going to be a bust. The National Association of Realtors has just come out with a new report that sales of previously owned homes dropped 1.7 percent in November.

And there are other signs the housing market is headed for a slowdown in 2006. First, according to another new report, 65 of the nation's 299 biggest real estate markets are extremely overpriced, and are due for what experts call a "correction." In normal language, that means a steep drop in price.

Second, although mortgage rates did drop slightly this month, they have generally trended upward, and November rates were the highest of the year.

Finally -- and this may be the really big indicator -- fewer people are applying for mortgages. Mortgage applications fell last week to a 3½-year low. Houses are sitting on the market for a longer period of time. All of these factors point toward a cooling market.

Now, of course, that's good news if you're a buyer. Even the president of the National Association of Realtors is saying that next year will be a buyer's market.

Many people in the last few years have bought more than they can afford in real estate and have taken out extreme mortgages. As rates rise, some of these people are really going to get stuck, and we'll see a lot more inventory on the market driving prices down.

Jobs: Boom

The job market may be booming next year. There's some concern that a slowing housing market could hurt employment, but other signs point toward a positive year.

There were 215,000 new jobs created in November, compared to 44,000 in October. This rate of job creation should remain stable in December with an additional 200,000 new jobs predicted.

A new major employment survey found that nearly one in four (23 percent) employers expected to hire more workers for the first quarter of 2006.

And a new Federal Reserve survey found reports of shortages of specially skilled workers in some markets, including health care, finance and construction. This could be good news for those looking for work.

Stock Market: Bust

Let's look at the indicators. Rising interest rates are bad for stocks. Investors realize they can get lower-risk returns when investing in bonds when rates rise.

Corporate earnings are slowing because of rising rates and inflationary pressures like higher commodity prices -- not only oil, but everything from steel to sugar.

Year-over-year comparisons are going to be less favorable, because the last couple of years companies have been rebounding from such low levels.

Since the bull market after the bubble burst, we've already had a big move-up in the market. The S&P 500 recently reached a 4½-year high. Even the Dow Jones can't be counted out as it nears 11,000 again -- a level it hasn't seen since June 2001.

Some areas of the market, like undervalued, medium-size companies have had annualized returns of 25.5 percent over the past three years. When I see those numbers, I instantly think trees don't grow to the sky, and we're probably going to see a breather. It is not to suggest that people should abandon stocks. They need to take a long-term view and invest in high-quality companies that can withstand difficulty.

Inflation: Boom

Inflation may have a little boom. Although the Fed is working to curb inflation, your wallet may take a hit in 2006 -- and not from the cost of gasoline.

While gas prices are declining -- down to an average of $2.19 per gallon last week, compared to more than $3 at the end of August -- consumer-product prices are on the rise. For example, the cost of Clorox bleach and Glad trash bags will each rise 8 percent. Anheuser-Busch has also announced that it will be raising prices and cutting discounts in 2006. In addition, according to a recent survey, one-third of all small businesses say they will raise prices in the first half of 2006.

Mellody Hobson, president of Ariel Capital Management (arielmutualfunds.com) in Chicago, is ABC News' personal finance expert. Matthew Yale and Aimee Z. Daley contributed to this report.