Felix Salmon

The stocks-housing disconnect

By Felix Salmon
May 31, 2011

The double dip in the housing market — with house prices nationally now back to their 2002 levels — stands in stark contrast to what’s going on in the stock market, and a lot of people, myself, included, are puzzling over why that might be.

A few charts would seem to be in order here. First of all, the Case-Shiller house-price index, the blue line on this chart:


It’s pretty clear from this chart that house prices are going down rather than up, and have been doing so for a good five years at this point.

Next there’s houses priced in stocks:


This is particularly interesting because it dates the big decline in housing as a worthwhile asset class all the way back to the early 1980s. You can see the housing bubble and bust in the spike at the end of the chart, but you can also see that this is a very volatile series, and that houses can and probably will become much cheaper still, relative to stocks.

Cullen Roche, looking at these charts, concludes:

Despite all the attempts to manipulate the real estate market, the government has largely failed in attempting to stabilize prices. In other words, it’s undergone a much more natural price discovery process. The equity market, of course, has been intervened in at every step of the way and the government has undoubtedly succeeded in propping up this market.

I don’t agree here at all. The government has done much more to intervene in the housing market than it has in the equity market, to the point at which the government at this point guarantees the overwhelming majority of mortgages. There’s nothing natural about the housing market price discovery process, and there won’t be anything natural about it for the foreseeable future, unless and until banks start taking mortgage risk again. And the large number of houses which have been sitting on the market for well over a year now is proof that this market isn’t clearing and that a lot of homeowners are still pretty delusional when it comes to what they think their home is worth.

But still the question refuses to go away: why is there such a difference between the housing market and the stock market? It’s something to do with investability, I think, because if you look at ways to invest in the housing market, they turn out to behave pretty much like stocks, rather than like houses. Here’s the Vanguard REIT ETF, overlaid with the S&P 500:


The point here is that houses are largely insulated from the kind of capital flows which drive everything from the stock market to the price of gold. There was a brief speculative bubble in housing from about 2000 to 2006, but even then the capital being deployed was largely borrowed rather than invested. Real estate is and always will be a game of debt: it’s almost unheard-of for people to buy up investment properties for cash.

The other weird thing about the housing-stocks disconnect is that it seems to be peculiarly American. There have been gruesome property-market crashes in other countries too, of course — look at commercial property in Ireland, or speculative beach resorts in Spain. But in general, countries with much larger property bubbles than we saw in the U.S. have seen property prices fall much less during the bust. And indeed there are brand-new property bubbles popping up all over the Pacific Rim: what is it that’s causing huge demand in Sydney and Hong Kong and Shanghai and Vancouver which doesn’t seem to have any effect on San Francisco?

I don’t have any good answers here, except to say that if housing is getting cheaper, in many ways that’s a good thing. Sure, it’s bad for banks, and it’s unpleasant for anybody who bought a house as an investment. But in general, the less money we Americans spend on housing every month, the more money we have to spend on more productive sectors of the economy, and the higher our disposable incomes. Falling house prices don’t make people richer. But they can make you feel richer than if you were spending hundreds of dollars more per month on a mortgage.

16 comments so far | RSS Comments RSS

You can’t say housing is getting cheaper based on values relative to the S+P, as most people in the US don’t make their monthly mortgage payment with S+P shares (okay, you can say it, but it doesn’t mean anything). They depend on income for that, and the price of houses is more dependent on income and interest rates than on stock prices (except for those of us who make money by trading stocks). And when foreign capital flows into the US, it’s not to buy houses, but to buy stocks and bonds, and maybe lend money to buy houses.

The housing price charts are relatively meaningless statistics, as there is not one housing market in the US, but lots of them, each with their own set of economics. There are many areas with way too much supply, and they will drag prices down for the whole nation. What would be more interesting is a average (unweighted) change in different markets, for if a handful of markets were skewing the whole nation, this would be more visible. The charts you show are not evidence of any recent trend, as the markets were totally distorted by the massive influx of cheap and unrestricted capital in the first half of the decade, causing instability that still hasn’t dissipated. If you inject a step function into a complex system (especially one with a lot of positive feedback loops), you will get the bounces we are seeing, and if the amplitude of the first bounce is high enough, there will be more than a second bounce.

Posted by KenG_CA | Report as abusive

I agree that housing is much more tied to the real economy than stocks, although mortgage debt and margin buying aren’t entirely different.

Housing is still fundamentally tied to demography and levels of income in a way that stocks are not. It is a primary necessity. People buy houses primarily to live in them or to rent to others. (They entail costs of ownership: maintenance and recurrent payment of taxes). There’s a finite (if broad and uncertain) limit to housing, even though we have recently seen excessive housing investment, REITs, and mortgage derivatives influence these limits. But housing is only one part of the total assets of an economy.

Stocks, on the other hand, can be created at will — or at least in response to many different assets and new forms of value. Their relatively expanded value is one indicator of the growth of the financial sector vis a vis the real economy. They are relatively liquid while, on occasion, offering the possibility of large gain. Cost of keeping them is minimal (or largely hidden?). Their level of value is not directly tethered to any underlying economic reality (whatever RBCT says).

A less severe recession can involve the decline of the stock market or one sector thereof, but I think that any widespread economic depression — one with “real” economic effects — must always involve housing (or, previously, land). For a real depression to take place, the bubble must inflate some asset tied to the real economy that lots of people actually need. The inflated value is popped when it collides with some brutal demographic fact: there are not enough people with high enough incomes to maintain the asset price.

Posted by jbernar | Report as abusive

There IS huge demand in San Francisco. It just doesn’t happen to be legal to build new housing to meet the demand, thanks to the very effective local NIMBY crowd.

Posted by SohoD | Report as abusive

I think the US house price-stock market disconnect and the difference with other housing markets is due to several unrelated issues:

1. The US’s Gini coefficient has been steadily rising over the past decade. It is now equivalent to many emerging markets (e.g. China, Argentina, Madagascar, Mozambique) and does not look at all like Canada, Australia, or Europe. Houses need to be bought by people. Since the median household income has been flat and the credit bubble imploded, there is little driver to maintain house prices.

2. In case nobody has noticed, unemployment has really not gone down over the past couple of years. It is very high compared to the other markets that you referenced. Unemployed people are usually not going to buy houses. It is probably not coincidental that the approximate rise in the unemployment rate approximates the decline in homownership over the past few years.

3. The stock market valuation metrics that I have looked at are flashing red (Shiller 10-yr real PE and Tobin Q). These indicate that the stock market is overvalued by 25% or so, probably because of Bernanke’s pump-and-dump scheme of inflating stock market and bond market asset values with cheap, plentiful money. This is finding its way into the pockets of a select few who are “investing” in very liquid assets like stocks adn bonds. This money is not really available to the illiquid housing market.

4. Three of the four markets that you cite as holding up well are Commonwealth countries. Two of those are in areas with very stable governing structures and have natural resources. Both Canada and Australia are quite welcoming to immigrants, especially from other Commonwealth countries. Many people from Hong Kong and China have bought houses in Australia and Canada, especially sydney and Vancouver. Very few of those people would consider buying in the US due to immigration and other restrictions. Foreigners are beginning to buy US housing stock, but probably more as a bottom fishing investment than an escape hatch.

Posted by ErnieD | Report as abusive

Nationally, housing is determined by land and construction costs and should be fixed in real terms. It is only in metropolises where congestion leads to land prices rising with incomes that housing should advance more than that and only insofar as median incomes grow. The reason housing was high in 80 was as an inflation hedge. Without that it should always fall relative to equities which grow with the economy, capital, and income skew.

Posted by MyLord | Report as abusive

If San Francisco has huge demand, then why do we have the highest percentage of vacant homes in the Bay Area? And why are there so many “For Sale” signs everywhere, some over two years old? The rental market is starting to show life but nothing like our normal.

Blame NIMBYs for something else.

Posted by indoorcamping | Report as abusive

A couple issues stand out when comparing the value of the S&P500 index vs the value of U.S. residental housing stock:

#1 The majority of the value of the S&P 500 represents overseas sales and earnings. It’s really a global idex.

#2 Earnings for the S&P 500 will break or nearly break their all time high in 2011… all else being equal that justfies a near all time high index price.

#3 As many others have posted U.S. housing stock is almost exclusively owned by American citizens so the value of that index is always going to be effected by things like job growth, income growth, the strength of the dollar relitive to the “1st order commodites” (the ones you buy before making the mortgage payment like food, heating oil, toilet paper.)

All in I’d say that housing is pretty fairly priced in most markets, underpriced in some parts of Florida, NV, and the rustbelt, and still overpriced near but not directly abutting the coast.

Posted by y2kurtus | Report as abusive

If there was a healthy real estate market, I would sell my house and ask $500,000. The buyer would have to come up with $100,000. Who the hell has $100,000? Not a middle-income family whose income is going down while prices are going up. Not a current homeowner who’s probably upside-down on his present mortgage or close to it. Not a retiree who is frantically counting his pennies and consulting life-expectancy tables. So, who, who, who is going to buy my house?

Posted by coughlib | Report as abusive

We have to be very careful not to compare apples to oranges.

The value of stocks comes from earnings, which are mostly retained and reinvested by the companies (especially over the decades you talk about). These companies then grow using these reinvested earnings. The dividend payouts have in most cases been a mere fraction of the earnings over the years.

The value of a house comes from the utility it throws off continuously over time. Unlike with stocks, where earnings are mostly retained and reinvested by the companies automatically, for most people the value of a house is continuously and completely disbursed to them.

If you really wanted an apples-to-apples comparison between stocks and houses, the houses would have to be ones that you own and rent out, where you keep the rent money to buy more houses. Maybe you pay yourself some small fraction of the rent as a ‘dividend’ now and then, just as companies pay out only a small fraction of their earnings as dividends.

Posted by DanHess | Report as abusive

The government has always backed the majority of mortgages in the USA. You’re acting as though this is something that the crisis created. That’s BS. Sure, the % of mortgages backed by the government has surged, but it’s always been in the 60-80% range. So no, there’s nothing that unusual going on right now.

http://www.doctorhousingbubble.com/wp-co ntent/uploads/2010/01/gse-and-government -mortgage-market.png

Posted by trader34342 | Report as abusive

Interesting comments.

I think the comments themselves are indicative about why there is the disconnect between the stock market and the housing market. Clearly people’s expectations of housing appreciation have changed over the past few years as shown in the comments.

Personally, I have always been puzzled about why there would be a general expectation that housing would increase at more than the wage inflation rate over a lifetime. After all, it is the classic “greater fool” type of investment where it will only be worth what somebody else will be willing to and able to pay at that time.

For some reason (probably flagrant abuse of securitization), the banking sector went stark raving mad a few years ago and relinquished their traditional role of being the adult in the room, telling prospective buyers that they couldn’t afford their dream home. We are now moving back to the long-term trend line.

Posted by ErnieD | Report as abusive

Felix, there are several difficulties with this comparison:

1) Equities started off at trough valuations in 1974. We are closer to peak valuations now.

2) Homes have little scarcity value outside of major cities. They are easy to create at low cost, as we see with the present oversupply.

3) There’s more leverage behind homes than stocks, including the internal leverage of corporations. We are still in a credit crunch now. Too much debt, too many homes.

4) Aside from the banks, corporate finances are in great shape. Profits are high, maybe too much so. Mean reversion may come.

5) Stocks are a middle-high-end good/asset, homes are a middle good/asset. The high end has done well with stocks, but has gotten hit on residential real estate.

6) Large corporations source a lot of their profits from abroad. Homes don’t, aside from flight capital.

7) We consume a larger proportion of the value of homes each year than we consume dividends and capital gains from stocks. More gets reinvested.

That’s my two cents, Felix. Interesting graph, all other relevant things equal…

Posted by DavidMerkel | Report as abusive

There is a disconnect between the real economy and the financial economy. Housing is in the real economy, or in the tank.

Stocks are in the financial economy, or la la land.

As for other economies (e.g. Australia, Canada), resource based economies should be seeing price rises in prime areas, like Sydney or Vancouver. Hong Kong has a history of property boom and bust, plus a real scarcity of land to put houses on.

Spain and Ireland have seen real falls. The Pacific rim and China really weren’t part of the crisis. The exception is the UK, not the US. Why have there not been big falls here? There is a land scarcity issue (and a difficulty in putting up new houses due to planning restrictions). But surely there must be a bust at some time?

Posted by Dafydd | Report as abusive

I’m wondering what this graph really means?

Is it saying that the average S&P500 share has appreciated more since the early 80s than the average house? Sure hope so!!! The S&P500 pays a *small* dividend. Maybe 2% on average. The “dividend” thrown off by the house (difference between rents and tax/maintenance/utilities) is substantially higher. Thus if you simply compare appreciation, and ignore the dividends, you’ll reach a meaningless conclusion. This was Dan Hess’ point, I believe?

Also agree with y2kurtus. The stock market has rallied due to globalization. Take away those global sales and revenues would drop 50%. Take away those international supply chains and profits margins would be squeezed. I do own a few foreign-listed multinationals, but for the life of me I can’t figure out what difference it makes (except for taxation).

Like ErnieD, I’ve been selling stocks over the past eight months. I’m not exactly calling a decline (that’s a fool’s game), just responding to valuations. Right now, my money is better used paying down (mortgage) debt, despite the low interest rates. Feels a lot like it did in the first half of 2007.

Posted by TFF | Report as abusive

Comparing the US and UK, one difference is the US ‘walk-away’ mortgage with no recourse to the borrower. They simply don’t exist in the UK. That means, if your UK house falls in value you still owe the whole debt so giving up the house to get rid of a debt higher than the cash value not only gains nothing, it just isn’t possible.

Since house prices are supported by high demand and inversely, depressed by increased supply such as vacating your property creates, house prices will fall less in the UK than they will in the US, even if the economic pressures and other factors are broadly similar in both countries.

Posted by FifthDecade | Report as abusive

This may be primarily due to demographics. As baby boomers are selling their house to fund their retirement, house prices continue to slide. Besides baby boomers are more investing in annuities and other safe haven and moving away from real estate. Some nice facts and stats from bankers life and casualty company here.

Posted by RICKCHARLES | Report as abusive

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