Stock market gyrations have taken center stage since year-end. However, while price drops dominate the headlines most Americans have a bigger investment in the homes than their 401Ks. As such, I’m getting an increasing number of questions along the lines of “How will the recent selloffs and spike in volatility impact sentiment over the level of future home price appreciation (HPA)” or “how do I hedge against a price decline”.
I tried to help answer the second question with yesterday’s blog (Jan 21). The short answer to the first question, at least as measured by reactions in the Case Shiller housing futures markets is “not much”.
First, note (in the graph on the left) that housing futures prices are forward looking, while the Case Shiller indices measure the past (and with a lag). Thus you can observe that, since the fall, while home price indices have been rising (and this is what the press tends to focus on) the housing futures have been trending lower. Since the futures prices settle on the index value at expiration, the two lines should eventually converge. It can be argued that declining futures prices may be consistent with the notion that the expectation of that point of convergence has headed lower.
A benefit of a futures contract is that these prices moves are updated continually, are readily accessible (e.g. CME, Bloomberg), and that the quotes are at levels where traders are willing to back their opinion with their capital. My sense is that housing futures prices might be useful for those looking to answer the (“what impact”) question posed above.
The graph to the right shows the closing prices of the S&P500 index (right scale, in red) versus the closing prices of the CUSX16 housing contract (Nov 2016 CUS 10-city index, left axis, in blue). Some argue that stock market prices reflect the cumulative expectations of forward dividends (and thus earnings). As such both indices reflect views of the future. (That said, sentiment, hedging, differences in time frame, risk preferences and other factors can all drive trading decisions).
I’ve left the scale (in this second graph) for each index proportional (note that S&P index scale is 10x CUS) to give a better sense of proportional moves in each index.
Note that the moves in the housing indices are a small fraction of those in the S&P 500. While the stock market had sold off almost 250 points since Oct 31 (or about 12%) by Wed Jan. 20), the CUSX16 contract had declined by just over 1%.
Note too (not shown), that the volatility associated with the changes to housing futures has been <10% of that of the stock market (since Oct 31).
There may be a mix of reasons that are consistent with the relatively muted reaction of home prices to stock market changes. On the one hand, homeowners might see immediate cash flow benefits from dramatically reduced heating costs and lower interest rates. On the other hand, a negative wealth effect, greater financial uncertainty, possible prospective job losses (e.g. oil sector) and, longer-term, higher local taxes to shore up public pension funds (that have been hurt by the market selloff – see Chicago as a Exhibit A) might all weigh on home prices going forward.
Hence,”the market” seems to be saying “not much” of an impact (at least on the broader, 10-city index, although I wouldn’t be surprised if home prices in certain regional areas, e.g. NYM, SFR where home prices are higher, where the negative wealth impact might be greater, and where foreign capital has contributed to upward prices, might experience a greater sensitivity to changes in the stock market. (See Jan 21 WSJ article “Slide Cools Off Luxury Property Boom” for an article focused on London. Also tune in to next week’s “Global Housing and Mortgage Outlook” webinar from Fitch.) The same graphs can be run for those contracts if any cares.)
Note that all of the above should be of interest to asset managers. Home prices (at least as measured by the futures) -and not “housing” – seems to be a sector with low correlation to the stock market, and with low volatility. The market for home prices seems likely to have much more of a domestic exposure than some global stocks, where revenue from their overseas operations drive earnings. Portfolio managers clearly would have been better off with home price exposure than stocks over the last few months. The issue of whether that makes sense going forward, or at different entry points given different levels of the stock market, is one that I’d be happy to discuss.
Feel free to contact me (firstname.lastname@example.org) if you like to discuss any aspect of this blog, or if you have questions on how to implement housing derivative strategies.