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In the Market - October 2008
Oct 15, 2008
How's Housing?
The current unprecedented levels of day-to-day market volatility are being driven by fears related to the government bail-out plan, though the longer-term stability of the markets is balancing on your neighbor's ability to sell his house at a fair price. The residential real estate market - which has defied the laws of logic for the last 10 years - needs to stabilize to restore liquidity to the credit markets. So, what is the "fair value" price point for the median American home, that magic number that will stabilize the credit markets? Looking at the relationship between housing prices, equity performance and unemployment rates can help give us an indication of where the balance point should be. The chart below shows the time series of inflation adjusted housing prices, the U.S. unemployment rate, and the quarterly performance of the S&P 500 going back to 1975.
As one would expect, housing prices and equity performance have historically shown a negative correlation to unemployment rates. The two notable exceptions to that logic have been the dot-com bubble in the late 90s and the real estate bubble of the last decade. In the late 90s, housing prices followed the huge stock market surge to new highs. But when equity markets corrected in 2000 and unemployment rose, housing prices kept rising breaking from their historical relationship. Now that housing prices and equity markets are both in the process of correcting, we see the laws of logic that have historically governed the relationship between housing, equity performance and unemployment returning to power. Based on a return to the historical average trend line, adjusted for inflation, a range of 170,000 to 190,000 would be an optimum price point for the median U.S. home. This would represent a 30 - 40 percent drop in housing prices from their peak in Q1 2006, and a further 10 - 15 percent drop since Q2 2008. However, given how far housing prices over shot on the upside, we wouldn't be surprised to see an overreaction to the downside as well before housing, the stock market and unemployment return equilibrium.
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