Falling house prices wouldn’t trouble stockmarket
Posted on June 12, 2007 by Richard Beddard
Filed Under Markets, Investing |
Judging by comments like this one from Stuart, a property crash is the catalyst we fear most:
It is curious that neither Richard nor Robin [a regular contributor] make mention of the greatest threat to the present stock market: namely, the spectacular bubble in the British housing market, which, when it bursts, will have a huge impact on all asset classes. See an interesting website, housepricecrash.com, examine the graph and prepare to be scared, very scared. I can remember the last bear market and its impact on my portfolio: it seemed to go on forever. A prediction: the next will be even longer.
Pretty bearish, then. John Kay, the economist and veteran FT columnist, had this to say about markets in 2004:
For many years, finance theorists believed speculative market prices followed a random walk: tomorrow’s movement was as likely to be down as up. Benoit Mandelbrot’s recent book* summarises the strong evidence that has now accumulated that price series display positive serial correlation in the short run and negative serial correlation in the long run. Translated, this means that if prices rose last month they will probably rise in the following month also: but that a period of several years in which prices rise by more than average is generally followed by a period of similar length in which prices rise by less than the average. But just how long is the long run? This is one of the great imponderables of economics - the only certainty, as Keynes explained, is that in the long run we are all dead. The precise interval at which serial outperformance gives way to serial underperformance is itself unpredictable. The consequence is that bulls are usually proved right immediately, and bears are usually proved right eventually. That is why both groups stay in business, and why neither has any profitable information to impart.
I chuckled when I read the last sentence. What if you are bullish in the short-term (next year or two), but acknowledge a correction will come some time after that? I’ve been following that line in recent posts speculating about the stock market. Is it doubly right, and just as useless? I don’t think so.
The intellectual basis for a sustained bull market is the spread between the global earnings yield and global bond yields, explained in this post. It gives us an indicator by which to gauge the state of the market, a potentially profitable piece of information.*1
No doubt, house price forecasters have similar tools but I’m not going to get into forecasting the housing market just yet. This is a stockmarket blog, so there is another question to answer first, which is: do house price bubbles matter?
They might. Colin Green, a contributor to this blog, surmises:
A small interest rate rise at this point could tip a lot of people into the red, resulting in mortgage defaults and house price falls. Drying up of disposable income to service debt could also eradicate a lot of business models with subsequent knock-on effects there. In short there is a lot of pent up risk aversion out there, which increases the chances of a sharp fall in all asset classes at some point versus a steady decline or plateau.
For an indication of where that line of thinking can take you, see The Big Picture. According to Barry Ritholtz, falling house prices in the US are already denting consumer confidence, and causing them to spend less, presumably:
And yet, some fools continue to insist that the housing slowdown is having zero impact on the broader economy. The best result to that silliness comes from Raymond James’ chief strategist, Jeff Saut…
Quoting Mr Saut, he reports on declining shipments at home appliance manufacturers and layoffs at retailers and banks. But, says Mr Ritholtz
The final chapter in the impact of Real Estate on the broader economy has yet to be written . . .
Quite right. Stockmarkets are flinching a bit, but I’m not sure about the ending he’s hinting at. For house-price falls to end the bull run on stock markets it must override all the factors pushing them up; principally a strong global economy and corporate profitability, which begs the question, asked originally by another reader, Nigel Taylor:
One of your correspondents mentioned the property bubble. You may want to investigate the correlation between property and stockmarkets. I have never found a chart that provides this correlation over the long term-trend. Perhaps you will be able to find one.
Which is, sadly, where I rapidly get out of my depth. Help is at hand though from a number of sources. I emailed Steve LeCompte who runs the CXO Advisory Group blog. He fired back this quick reply:
I have not posted on this topic, but I took a quick look at the change in median prices of existing U.S. homes versus the change in the S&P 500 index for 1969-2006 and get a weak negative correlation. That means a slight tendency for home prices to rise more (less) when stocks decline (advance). I’ll try to post something about it tomorrow with more details.
He’s posted already, and you can see the chart and his working out here. I won’t duplicate it because I have another chart which tells a similar tale. It’s from Fisher Investments:
The chart shows year-on-year house price changes in the US. Analysts at Fisher have ringed periods of flat or falling house prices and measured stock market returns in the period soon after. Here’s a table:
“Stocks were positive—nicely so—6 and 12 months out. Flat or declining home prices just aren’t triggering stock market catastrophes—there’s no evidence of that,” says my contact at Fisher.
John Calverley, chief economist at American Express Bank, and author of ‘Bubbles and How to Survive Them,’ says that’s because house price crashes are unlikely to trigger stock market crashes unless they occur in tandem with recessions. I’m quoting his email verbatim here, starting with the historical correlation between house prices and stock market prices:
The relationship between the two, historically, is not very helpful. In the cycles of the past, stocks usually peaked first and then, a couple of years later, house prices peaked and then were weak. But this clearly did not happen this decade. Stock prices peaked in 2000, then fell sharply but house prices went up. This was true in the UK and US and just about everywhere in the world, though some countries have seen the rise in house prices more recently, after stock prices were again rising from 2003 onwards. The reasons were the very sharp drop in interest rates this decade and the huge fiscal stimulus in the UK and US.
My view now is that a crash in house prices (as may be unfolding in the US) could only cause a crash in stocks if it looks like taking the economy into recession too. And the picture in the US is that consumers are still confident and are still spending despite falling house prices (they are down about 3% from the top last summer on average). Part of this is due to the fact that stocks are rising so Americans’ wealth is still rising.
My bottom line is that I think recessions cause house price crashes not vice-versa. (This view has firmed up a bit since I wrote the book). But I also think that if, or I should say “when” we get a recession, the fact that house prices everywhere are too high (in my view), means that the recession will be worsened by weak house prices.
I am not expecting a recession in the next year or two. Usually US economic cycles last around 10 years so we are not due a recession until around 2010.
The UK of course avoided a recession in 2001 (due to the huge fiscal stimulus and rising house prices) but will not avoid one the next time - no room for fiscal stimulus and house prices are too high.
Here are some tentative conclusions on why falling house prices do not drag the stock market down, following my enquiries:
- Often they’re not significant enough to overcome the factors driving the stockmarket up.
- When house prices fall, investors pull out of property and invest in stocks, a factor suggested by Fisher Investments.
- Stock markets adjust to fears about housing before those fears fully materialise so the bad news is already factored into prices. As one reader of this blog commented:
I’ve been anticipating a property crash in the UK for the last 7 years but it never seems to come.
Whatever the reasons, while nervousness about house prices remains, a stock market crash doesn’t look likely soon. As I have mentioned before, in a year or two’s time things could be different…
But remember this salutory observation from John Kay:
Three predictions can be made with confidence: that housing is a good long-term investment, that the current boom will be followed by a slump, and that people who make confident predictions about the future of house prices are mistaken.
It applies to stocks too 
Footnotes:
- The global earnings yield/bond yield spread is Ken Fisher’s creation. I will publish his latest figures very shortly.
- I interviewed Benoit Mandelbrot in 2004 about his book, ‘The Misbehaviour of Markets’, it was probably the highlight of my working year.
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19 Responses to “Falling house prices wouldn’t trouble stockmarket”
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Fisher also makes at least two other points related to bullishness: demand for equities greater than supply, and third year of a presidential term in the US.
In my opinion, house prices have tripled since 1997 due to specific factors: mothers going out to work, low interest rates due to low inflation due to switching manufacturing to China, and buy-to-let mortgages. (Other demographic factors are often quoted such as the divorce rate and longevity, but these are much longer-term and affect every country.) Now almost every mother goes out to work, everything is now made in China, and buy-to-let doesn’t make sense at current interest rates. So it seems to me that the housing market outside London is like a
cartoon man who has run off a cliff - his legs are still going round but he’s just about to plummet.
Here in the North of England, house prices are already stationary, and this has not been commented on by the London-based media. On my new estate, houses go up for sale and just stay for sale for months. I’m renting my house
for a little over half what I would have to pay in interest alone if I wanted to buy it, so my landlord is effectively subsidising my housing by several hundred pounds a month. Not a stable situation.
It is the labour Government that fused the rise of housing market to show their “best performance” in governing the country.
Wether is it labour Government or conservative Government, they all do not think of the benefit of the country nor its citizen, but the big fat salary, allowances and pension they will get.
Low interest provides citizens to have their own home is good idea but buy-to-let policy so as pension buy-to-let are encouraging slavary. Worth of all, most landlord having huge number of houses are not native British, ” Briton will not be slaves again” does not work at this century.
The new prime misnister is going to face the consequences created by himself in medium term or he most probably lost the election by that time.
More people refused to pay for high rent and choose to be incapable to work due to “depression”, ” anxiety”" metal breakdown”, more benefit is paying out although unemployment rate is low. The society / country is not healthy at all.
Low housing cost, fuse and transport cost, and utilities bills will encourage healthy thinking, healthy citizens that meke a stable society. Selling the utilities and transport to private sectors had already lost some available support to a prosperous and healthy society, high fuse cost and housing cost made the situation worse. Rich Britons had move out pocketing the money collected from the housing market. New immigrants are not buying by putting up with more people in a house, check with the society security / benefit agency how many house rent they have to pay out every month Please.
The ministers and government are not fool, they get the immediate benefit, it is you the citizen of the country who will face long term problems.
Learn from the Scottish people — have a a government without majority seats. Get rise of your politician if he/ she did not work to your satisfactory.
Hi Keith,
I think you are correct that the buy-to-let market has no money in it anymore and this will probably cause the housing market to peak very soon. If interest rates continue to rise then this may cause some sell-off but not a significant crash I would have thought (but I am no expert). Something else will need to happen to break the equilibrium (e.g. interest rates doubling would probably do it).
I have one question however which perhaps a reader can answer. When people say that ‘supply’ is greater than ‘demand’ I do wonder if ‘demand’ is from the buy-to-letters or, for example, from the new wave of immigrants.
In the latter case, I could understand that there might be a genuine shortage of homes for people to live in. In this case, perhaps the government can keep the bull market going by building new homes indefinitely (or at least until the whole economy runs out of money).
Does anyone know in what proportion the buying is actually happening right now? For example
1) Buy-To-Let From UK
2) Buy-To-Let From Abroad
3) New Buys from within UK
4) Government purchases
Very interesting post Richard.
I lived in Bristol in 2005 and when I punched the buy-to-let numbers on their housing market it was economically feasible, but I have no idea how the housing market has grown since then.
http://makingsenseofmyworld.blogspot.com/2007/05/low-interest-rates-as-destructive-as.html
I have been having a discussion on this issue with an American friend. I told him that I thought the US housing market was in much greater danger than the British one strictly because of population density, Britain having more than 5 times the population density than the US.
It seems that Britain has little land to increase building housing on and to do so would strongly hit agricultural reserves, and I’m not so sure Britain has enough to feed the population now. When I asked a wonderful retired teacher I met over there if Britain had enough land to feed its people she started talking about the war. She talked about how imports were cut off and Britain had to rely on itself. She said people did not starve, but sometimes you were hungry, and British population has grown 20% since then.
So, often we hear about placed being land locked for not having land for new housing, but that simply isn’t true for Canada or the US, but it seems reasonable that it is true for Britain because of the much higher population density meaning that your buy to let market doesn’t get wiped out by simply putting in a few more housing developments. I think it is more challenging to increase housing in Britain.
But remember this salutory observation from
although stock markets have given higher real returns in the long run;
and the length of long term depends on when you buy;
and you can make confident predictions so long as you have some idea of your level of confidence e.g. 99% chance that enormous overvaluations lead to plunges in prices sooner rather than later.
In my opinion, and I’m no expert, house prices must drop. My reasons are as follows :-
Young people have to borrow in some (extreme) cases 7 times their earnings over 40 years to buy a modest property. This cannot be sustained.
These people will never be out of debt and if interest rates rise by a mere 2% they will be on the streets !
Some people are mortgaging their property to obtain a deposit on a house for their children - unprecedented.
I am now seeing many properties going for sale and then disappearing from property websites. I’ve then seen (by pure chance) the same property on another website at a reduced price. Many going O/O to fixed. I’m in central Scotland.
The property market is at the same stage as the stockmarkets were before they crashed - out of control.
People are too eager to listen to the advice of estate agents. Let’s face it they’re not the most intelligent people on earth. Their method of valuing property is seriously flawed & prices are overly influenced by a single sale.
It’s spinning plates & they’re ready to come crashing down.
Inflation has been kept low but it can’t be kept down forever because house price rises forces up salaries which increases inflation resulting in interest rises so the property market which is man made will vapourise.
The smart money is leaving property & the fools are coming in to take their place & will be left with debts.
Property - as an investment - will not make any return over the next 5 years.
The only people who will profit will be the banks.
Question : What would happen if house prices crashed by 50% today?
Answer : A lot of people would be very happy and immediately start buying properties!
It is this answer which makes me think that the property prices are unlikely to crash.
They are more likely to drop a bit (so they become profitable/just affordable again).
The point is people not only expect a crash, but they want a crash, so it probably is not going to happen (or will be strictly limited in size and duration).
Nowadays, if you cannot afford to pay off a bad loan then I think there is some legislation to write off the rest in any case.
Therefore you may as well take the risk and keep buying.
Jim some good points. I think however that many people are looking at the housing market as a homogenous thing. It’s not. It’s made of many different sectors. For example where I live in central London on the border of Bayswater/Nottinghill/Kensington house prices are still increasing at a steady rate and there is a very real shortage of property. I disagree with one point you make above Estate Agents do not dictate the price of property it’s what punters are willing and able to pay that does that. People are pretty savy especially at the end of the market in these parts. If we see reverses in prices as opposed to a “crash” I think there are many areas that will be immune. After all there will certainly be no new estates or housing projects in the areas I mention above every square inch of land is already covered and priced accordingly. What may tip the balance is a recession and / or serious increase in interest rates. There are many people able to afford property at these prices and in wealthy areas there are many forigners with stacks of cash from India/China/Russia who are keeping on buying. I have a few B2L but agree with some of the above contributors now is not a good time to be jumping into that arena though there are still some places that work if you know your market well and wait for the right property at the right price.
I believe that in general house prices are already falling (albeit very gradually) in most parts of the country, with the possible exception of London.
Don’t forget that most measures of house price inflation are 1) historic, meaning that there’s a delay between the collation of price data and its publication and 2) weighted ie more expensive homes have more influence on the statistics.
The second point is of particular relevance in London where, in economic terms, the City is thriving and expectations for continued healthy bonuses are high. In the short-term, this will keep demand for prestigious homes high unless there’s a shock of some sort eg rapid escalation of violence in Middle East, threat from Russia over energy. Either of these would cause oil prices to rise, higher inflation and subsequent interest rate expectations impacting financial markets.
Outside London, homeowners with variable rate mortgages will already be starting to feel the squeeze on their finances following the recent interest rate rises and continuing “stealth” taxes. However, consumer spending habits can be slow to change, which explains why it can take 18 months for an interest-rate change to really have an impact on the wider economy.
I believe that a house-price “crash” will only occur if the economy really slows and unemployment rises significantly in a relatively short period of time. However, I can easily imagine house prices falling gradually for the next 3-5 years (perhaps by 20% over this period) as consumer spending and economic growth slows. It’s also worth pointing out here that economic growth over the last decade is largely attributable to high public spending by the government (which ultimately will have to be paid for by taxpayers) and a prolonged period of low inflation and low interest rates (at least partly attributable to cheap imports from China).
Sorry guys, but the future’s not bright unless you’re in cash…
The housing market in the uk bears little relation to the stock market. It is enormous, it directly affects every individual (unlike the tiny minority who are involved directly in the stockmarket), and it has a stunning level of inertia built into it.
The stock market turns in 24 hours and reflects the state of the international economy more than UK house prices.
The average household in the UK moves home every 7 years, and only a minority are carrying mortgages very close to their affordability limits. So most householders are for practical purposes unaffected by price movements. A crash can occur, but most
people will barely notice it, as they were not thinking about moving home, anyway.
The key word here is “home”. A house is not an investment for the majority of owners, it is a place to live, and a mortgage is simply a low cost (long-term) alternative to rent.
The rise of the buy to let landlord is in my view a bit of a one-off. The scheme took off about ten years ago, because house prices in the nineties had fallen so low in real terms, rents were higher than borrowing costs. That was an anomaly and it has ended. Anyone who still buys a house for buy to let is coming after the fair. The profits have been made. Do not borrow to buy a house to let until prices next look startlingly cheap, that could be years away or never.
How about that! You bust your gut to write about the relationship between house prices and share prices and nobody wants to talk about share prices at all!!!
Oh well if you can’t beat ‘em, join ‘em. FWIW I wouldn’t be a buyer of property now (aside from the fact that owning one house I feel like I have a pretty big slug of my capital in property). I just dug out an interesting table from The The Sarasin Chiswell Investment Handbook. It shows total returns for property against equities since 1947:
Property 10.7%
Equities 12.8%
Long-term equities do better then, historically speaking. Over the last ten or twenty years I’m not so sure and property looks more overpriced to me. There you go, have I successfully steered the conversation back to the stockmarket? I doubt it
Also the property companies that converted to REITs in January and April are (all?) down since. I don’t know if it’s just that prices were a bit frothy in the run up to conversion or whether it reflects wider uncertainty about property but I guess it’s most likely both.
Financial illiteracy is at the foundation of the rising house prices.
20 years ago when the inflation rate was 10% and the real mortgage rate was 4%, the cost of borrowing was 14% and a couple could only borrow about 3 times their earnings, this limited house prices.
Now that inflation has fallen, and is 3%, and the real cost of a mortgage is 4%, the cost of borrowing is 7% and couples can borrow 6 times their earnings, hence house prices have doubled relative to earnings.
But here is the big difference. If we consider just the money paid to service the debt, 20 years ago, five sevenths (=10/14) of one’s mortgage payments were compensation for inflation (ie. repayments of capital), and two sevenths (=4/14) interest. Most of the debt service payments were paying off the loan. Today only three sevenths is compensation for the reduced value of the loan (ie.repayment) and four sevenths is interest charge.
Rationally the price of houses should have fallen to compensate for the reduced proportion of repayment, but most people are not financially literate, and think “I can afford £x per month on housing so I can afford to pay £y on the house” without ever calculating the sizes of the two components of the cost of servicing their debt.
My favourite discussion House prices.. very intersting on Stock Markets… house prices crash when the economy slows/interest rates rise and unemployment jumps up = people cannot afford to pay. New fixed mortgages and rising wealth reduce interest impact.. remember you can remortgage if interest rates go up to cover new payments (same argument as div vs capital growth).
The second factor in London more than anywhere else is supply and demand … no net supply .. huge increase in demand. Net population migration from Europe 1 million cumulative in 10 years plus rich people from RoW, and London I Bankers/lawyers, etc have driven demand and hence prices up…. shift of the curve upward… while supply has virtually stayed static… all bombed building sites gone between 1990 -2004 and you cannot really build high rises…. no supply. Check the data it tells the whole story… regions go up around London as people migrate outwards. In Scotland, Manchester … those are bubbles - no supply constraints and wishful thinking.
Further, London has special historical and contemporary cultural features that attract people above any city… Cultural tipping point turn of the century Paris, mid century NY, now London… 2010.. then start worrying or if G Brown screws us one more time with taxes…
Have fun I will keep my property till then … I am sure I will keep having this conversation same issues since 1993
Only an inch separates our noses from the charts and statistics as we scrutinise the data, however we may be missing an intangible part of the puzzle: emotion.
The common person, let’s call him Dave, gets his view of the world from limited information sources; he’s subtly shaped everyday by the information coming at him from the newspaper he reads, the headlines of newspapers he doesn’t read and the announcements coming from the television news (with the scary, “end is nigh” soundtrack).
Dave has a couple of mates that he drinks with. One mate has just moved into the new development with the lake and has one of those 4×4’s with the foldy-in mirrors. Dave feels secure; if you switch off the Iraq stories, all is pretty well. He orders a steak baguette and leafs through the property section. He’s elated that the Halifax has approved a nice sum which should afford him a place with a room above the garage.
There are a lot of stakeholders in the housing market, and this makes it profitable news. It’s the one investment that we’re all experts in. So when a national paper wants to shift copies, they know that “REPOSSESSIONS AT 10 YEAR HIGH” will draw attention. Of course, Dave will notice the 10cm tall letters as he stretches over to collect his change at the station café. On Sunday, millions will return from the corner shop and open up a two-page-spread on the future of buy-to-let. Where’s the article on dressing a room to sell gone?
Dave’s mate isn’t worried, he’s got 20% equity since he bought. Dave peruses the bar menu but decides that he wouldn’t pay £6.25 for a club sandwich and he wasn’t all that hungry anyhow.
In investment markets people are either trying to make, or trying to take a profit (or loss). Whether it’s for our pension or for letting-income, our housing market now resembles an investment market and people will either be greedily buying up, doing up and pushing up, or they’ll be scarily selling up and the buyers will be drying up.
I don’t think we can under-estimate the power of the masses, and I don’t think that the chart will break the habit of hundreds of years and go sideways.
I will continue to hold a house-load of equities, cash and gold until the risk is out of the market.
Luke
Richard, sorry for diverting the thrust of your original story. Stocks might beat property just looking at the basic percentage returns, but that doesn’t take into account the massive gearing and tax advantages available to property owners. To take one of the best stock investments in recent years as an example, if you had been prescient enough to buy Microsoft shares shortly after their IPO in 1986, and held them through thick and thin until today, you would have made 300 times your original investment over 21 years. Probably only a few hundred people in the world have held them constantly over that time - original employees or others with a strong emotional link to the company. And if you wanted to realise the gains now, you would be facing a 40% bill for capital gains tax.
Compare this to the millions of people who have owned their own house while it has tripled in value in ten years. For example, you bought a £100,000 house with a 95% mortgage in 1997. From your original £5,000 investment you now have equity of £205,000, giving a 40-fold gain. This is equivalent to a 1600-fold increase over the 20 years of the Microsoft shareholding. So millions of people have easily beaten one of the best share returns in the world, and what’s more for owner-occupiers there is no capital gains tax to pay!
With so many more people having made such massively greater tax-free gains over the past ten years, I don’t think it is surprising that the general misapprehension in the population is that property outshines shares over the long term. A 40-fold gain over the NEXT ten years doesn’t seem to me to be possible though, due to the absence of the three factors I mentioned in my previous post.
Hi Keith. No problem at all. I think I’d lost the thread the moment I said ‘house prices’
I’m having trouble getting my head round this one. I’m in the fortunate position you describe (regarding my house) and I don’t feel like it’s made me rich. However my more modest gains on the stockmarket, whilst they haven’t made me rich, are a source of satisfaction! I think that’s because the money in my house isn’t available to me (OK, it might be, in extremis, but realistically we hope not to downsize for at least twenty years). So, with the attendant costs of running a house, mine feels like a bit of a liability. As you can only avoid CGT on your residence, buying another property is less attractive, and the cost of the mortgage has to be factored in. Also the chances of capturing that 1600 fold return over twenty-odd years are a bit slim. I’m sure some people do feel the way you describe, but I’ve decided I’m not one of them.
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