Trading activity in the CME Case Shiller home price futures regional contracts during 2022 showed how expectations changed dramatically, not only at a absolute level, but between regions.
The graph and table below show the percentage changes in the regional contracts for both the Feb 2023 (G23) and Feb 2024 (G24) contracts throughout the year. For both expirations, all regional contracts moved higher in price until late April/early May. Such appreciation is consistent with both the market being surprised to the upside as each monthly index was announced, as well as a pull to convergence. By the second point, I mean that since I believe that contracts typically clear at a discount to expectations, that gap will erode as expiration approaches. That is, the discount has to disappear as the shorter-dated contracts approach expiration as the index and contract values near the same number.
As noted in Wednesday's blog prices peaked in May (well before indices declined) as users began to worry about home prices. Closes on all regional contracts fell, with the Feb 2024 contract prices falling harder. This makes sense as the Feb 2024 contracts went from trading at a premium to Feb 2023 (and spot) to trading at a discount. (This was even more the case for longer expirations e.g. Feb 2025-2026. Think of playing "crack the whip" while skating. The near expiration (or person) pivots causing an even greater turn at longer expirations, or to the last skater. )
Another way of looking at it, is when HPA assumptions change from +3% to -3% (across all years), it's a 6% change for one year, but a 12% change for two years as the forward prices run from +6% to -6%.
Net, G24 contracts are riskier/ more volatile than shorter-dated contracts. No surprise, then, that bid/ask spreads are wider.
Surprising to me (in standing back at looking at the year from a distance) was how prices on some regions moved versus overall market (i.e. the Case Shiller 10-city index contracts in red). Several thinly-traded contract prices (e.g. BOS, DEN, LAV and WDC) were highly correlated with the 10-city index contract. This makes sense as without standalone trading in the regional contract, prices on those contracts would move with the 10-city index contracts via Intercity Spread ("IC") quotes. That is, if HCIG23 offer dropped one point, and the HCI/BOSG23 IC spread didn't change, the BOSG23 offer would drop one point. (Note that this may or may not cause a change in the BOSG23 close if the offer was not below the prior close). Outright interest in these regional contracts, or challenges to resting assumption in the Intercity spread markets will be needed to break these correlations. BTW - if the correlations remain, even with higher volume, it would reinforce my notion that national home prices (driven by national mortgage rates, and nationwide lending standards at the GSEs) are the key determinant of most regional home price moves.
Some contracts, most notably CHI wandered much more their own way, and only had modest correlations.
The big outliers were MIA and SFR, with MIAG23 being up 12.25% on the year, while SFRG23 closed -12.44% (vs HCIG23 being -1.38%). These outliers scream at potential for trading opportunities during the year. For example, by Dec 2021, readers knew San Francisco was probably more likely to be negatively impacted by the tech community's ability to work from home. Further, by Dec 2021, readers knew of population gains in Florida and the unique flight of South American capital that fueled condo prices in Miami Beach. Yet, even knowing this in Dec 2021, the two regional Feb 2023 contracts had a performance difference of ~25%. (Note that for Feb 2024, the difference was close to 30%!)
This suggests to me that either: a) regional contract prices had not been absorbed all of this knowledge by the beginning of 2022, and that there would be future opportunities during the year for sharp readers to see that MIA was underpriced, and/or the SFR was overpriced, or b) that current prices reflect fears of these trends continuing into the future, and have each run too far. I can't change the first part, but I'm willing to dabble in buying San Fran/selling Miami (on a spread) in case users think that these two contracts have reasons to trend further. I will also entertain IC spreads against the 10-city index contracts.
Net, there are two messages here: 1) perspective (mine) changes when you take the time to step back and look at things from a distance, and 2) there are always opportunities to trade relative value, that is, beyond calling tops and bottoms in the overall market. (Note that while this can easily be accomplished using CME contracts, that I'm also willing to provide quotes on other cities (not referenced by CME futures). Anyone want to express a view on how far Phoenix might underperform, or how much Charlotte will outperform?
Feel free to contact me if you have questions about this blog, have an interest in adding/ reducing exposure to absolute or relative value in home prices, or if you'd like to learn more about how home price index derivatives can be used in hedging decisions.
Thanks,
John