Much noise has been made on social media over the last few days about Robert Shiller's "10% drop in home prices, according to CME Case Shiller futures". Let me see the record straight/support his call/ by highlighting recent quotes.
The table below shows quotes (a/o Thursday Aug 11 1:30 PM) on the current Case Shiller 10-city index futures. I've included bids, offers, closes, mid-market levels, and the "% vs spot" for each number. I've highlighted the Aug 2022 and Aug 2023 contracts
To confirm Shiller's comment, I'd buy the Aug 2022 contract 10% above where I'd sell the Aug 2023 contract. For example, I'd pay 330.0 for August 2022 vs (simultaneously) selling August 2023 at 297. (Similar trades are available on several regional contracts). A $1mm exposure would be 12 lots.
Now, while the price difference between the contracts is consistent with a 10% decline in the CS 10-city index, I'm not suggesting that home prices will drop as much. As I've often noted this pairs trade (actually a calendar spread) ties together two markets that reflect different viewpoints. For example, the Aug 2022 contract quote of 328.0/331.0 is slightly higher than the number (328.92) released in July. However the July number covered activity from March through May, while the index to be released on Aug 30th (always the last Tuesday of a month) covers April though June. Net, the index drops March, and picks up June as the 3-month rolling average advance one month. Bids and offers for the August 2022 index reflect sentiment that June will have higher prices than March. Importantly, however, the August 2022 index covers known events, i.e. home closings that have already happened so there's no reason to have a discount/premium to expectations.
On the other hand, the August 2023 contract will reference activity from April-June 2023, and the level of those closings is unknown. IMHO users looking to hedge the uncertainty of those future closes, or just trying to lock in gains, might be (should be?) willing to sell futures at a discount to whatever expectations might be. After all, people looking to reduce risk often pay premiums (I'll repeat from prior blogs, e.g. life, car, home insurance) to sleep better at night. Further, if a homeowner has seen price double in the last eight years, why not concede some discount to try and hedge a position.
The questions then becomes, how big is the discount from expectations (a very debatable topic)? I don't know, but I believe that a) it is larger in thinly traded contracts (such as these), b) it is larger when I sell "Sell" orders outnumber "Buy" orders by > 5:1, c) it is larger when there are no other public market alternatives, and d) it is larger in markets where natural longs don't participate. (I know that most institutions don't participate here, given volume).
That then suggests to me that a natural long that doesn't need immediate liquidity, and that wants to have some core exposure to home prices, might have a favorable risk/reward in buying forward contracts. The market has seen institutions participate in shared appreciation mortgages from 2018-2020 (e.g. Unison, Point as originators). Buying those involved some bullish views on home prices (and the imbedded payoffs). Why not have these same organizations consider longer-dated futures (traded on exchanges with public prices, leverage, and standardized contracts) as an alternative?!? I can't imagine personally offering $5mm worth, but I've seen $5mm of selling inquiries. We just need to match those interests to grow this market.
Net,
1) Shlller was correct in that forward prices are 10% lower, but I think that he (and many others) missed that forward prices may not equal expectations (in this thinly traded market).
2) There's an opportunity for natural longs to add exposure to home prices at discounts to expectations.
Please feel free to contact me if you have any questions about this blog, have any trading/hedging ideas that you'd like to pursue, or just want to learn more about how home price indices might be used in hedging strategies.
Thanks, John