Where are home prices headed in 2020 -The power of markets to complement historical analysis and opinions

Most of the research on home prices falls into two categories: 1) Analysis of what has happened, and 2) Forecasts of what might happen. While they are useful, there's an overlooked third component (that I focus on here): markets, that may also be helpful.

The power of markets are that 1) they are backed by people willing to put money behind their views, and 2) you can act on them. That is, two people can disagree on a forecast, but there's no (standardized) way to monetize a disagreement. One person can have an outlier forecast, but there's no way to hold them to their opinion. Markets allow a platform for two parties to meet and to express opposite views. Markets allow for win-win situations as one party may get to hedge a long position (reducing risk), while another may get to add exposure to an under-weighted sector. Markets allow users to change their mind, and don't require (in exchanges) that initial buyers and seller have to meet to unwind exposures. In theory, in a deeply traded market -i.e. one with public prices -there should be useful information that other viewers (i.e. those not even looking to trade) can give weight to, and incorporate into their outlooks. I'd like to have the CME Case Shiller futures get to the point where both viewers and traders and can more weight to posted prices.

One place to start might be on the question that gets raised at this time of year - i.e. where are home prices headed for 2020.

The graph below shows the results of converting Feb '20/ Feb '21 calendar spread quotes on into percentages. (See below for the conversion of prices into percentages.) Recall that the Case Shiller index has a two-month lag. As such, the February index release picks up activity through December. The Feb '20 contract references (and will settle on) the value of the Dec. 2019 index (to be released Feb 25, 2020) and the Feb '21 contract references the Dec 2020 index.^1

Additionally, recall that a calendar spread allows a user to simultaneously enter into a long in one expiration and a short in a different expiration (of the same region) at a predefined spread. Those spreads can be converted into percentage differences to show where traders are both willing to buy and sell risk on index moves.

Consistent with other research, the CHI (Chicago), LAX (Los Angeles) and NYM (New York area) calendar spread quotes are consistent with lower (albeit positive) HPA for 2020, while the BOS (Boston), WDC (D.C) and LAV (Las Vegas) quotes are consistent with higher gains.^2

Further, it's my view that forward markets clear at a discount to expectations. (More natural hedgers than natural longs, with speculators making up the balance). As such, one might make some small adjustment to reconcile these markets with forward expectations.

These calendar spread markets allow user to disagree with either the size of gains for an individual region, or even the size gains of one region relative to another. I'd be happy to facilitate trades in any of these regions. Feel free to contact me to discuss this blog or any aspect of hedging with home price index derivatives.

The table below shows my effort to convert calendar spreads (which are quoted in points) to implied gains.

A few notes:

1) Calendar spreads are often quoted as the front contract relative to the back. So if forward prices are higher, the calendar spread quote will show as a negative number. (See yellow highlighted area for this morning's quotes).

2) Since regional contracts trade at widely different values, a calendar spread in points on one contract may result in a different percent price difference than on another. For example, the LAX index is twice the size of the CHI index. Converting dollar-based point spreads into percentages allows viewers to see spreads using a standardized measure.

3) Calendar spreads quoted here all have bid/ask spreads of <= 1.0 point. I've tightened spreads to highlight the concept of converting points into percentages. Such tight bid/ask spreads may not exist forever. In fact, once the front end of the calendar spread expires (at the Dec 2019 index level), a user will only have the back-end contract. One-year forward contracts today are quoted with an average bid/ask spread (across 11 contracts) of 1.9 points.

Again, please feel free to contact me if you have any questions.

Thanks, John

^1 -This is one value of February expirations and why I include Feb expirations in the limited number of expirations I post quotes.

^2- Look for a blog to follow this, where I'll apply the same methodology to 25 regions referenced by Freddie Mac indices, where i'm open to entering into OTC home price index agreements.