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August 30, 2009
Edited: August 30, 2009
Share This-- Charles Mackay
Extraordinary Popular Delusions and the Madness of Crowds
In my Alternative U.S. Realty Realities blog-post series in February, I discussed certain aspects of U.S. home-price trends, which are seen here at the home office of the completely fictional Druids Investment Group (Can You DIG It?) as prominent both among the key bases of the past economic contraction and among the key foundations of the present economic expansion.
My main interest in home prices centers on their relationship with movements in the equity market, which was represented by the P&P benchmark Standard & Poor's (S&P) 500 (SPX) in this series.
I based most of the discussion in the Alternative U.S. Realty Realities series on the S&P/Case-Shiller Home Price Indices (http://tinyurl.com/5e5xne) in general and the 10-City Composite HPI in particular.
At considerable risk of being redundant, I note the following key points made in the context of this series:
-- One of the main assumptions underlying my analysis of home prices during the past 22 years was the applicability of the compound annual growth rate (CAGR) of 2.30% I calculated using the Historical Census of Housing Tables - Home Values (http://tinyurl.com/cswmk) data provided by the U.S. Census Bureau.
-- Comparing the 10-City Composite HPI's actual end-of-year values with the index's projected EOY values I computed employing the above-referenced CAGR, I concluded the actual and projected values appeared comparatively congruent between 1987 and 1999 (leading me to designate this time as the Normal Home-Price Period) and seemed relatively incongruent from 2000 to 2008 (leading me to designate this time as the Abnormal Home-Price Period).
-- The comparison of the 2008 EOY actual and projected values -- as well as an examination of the trend in their relationship -- indicated to me there was a high probability home prices might continue to fall in 2009.
-- Based on my interpretations not only of the 10-City Composite HPI data but also of other relevant information, however, I believed the momentum in the collapse of home prices might have achieved its terminal velocity in the second half of last year, and I thought this trend might move from acceleration to deceleration in the first half of this year.
-- Essentially, I suspected the mortgage-foreclosure rate -- a major driver of home prices in recent years -- would begin to moderate. Along this line, I suggested President Barack Obama's aggressive approach to dealing with the economy might eventually have a significant role, as the American Recovery and Reinvestment Act (http://tinyurl.com/dfptgm), Financial Stability Plan (http://tinyurl.com/bx6eun), Homeowner Affordability and Stability Plan (http://tinyurl.com/c4s5ej), and other initiatives all became fully operational.
-- As one who is more a stock guy and less a real-estate guy, I was happy to find the absolute and relative degrees of noncorrelation between these two markets led me to posit that "the one should be ready to start rocking 'n' rolling long before the other finishes getting the drums out of the van . . ."
During the six months since the publication of the Alternative U.S. Realty Realities series, the S&P/Case-Shiller Home Price Indices data releases (http://tinyurl.com/5v8u3v) and related events (e.g., the behavior of the S&P 500) have been more or less as I anticipated, except for the latest data release, which became available Tuesday.
As indicated in the series, I expected the monthly mean percentage decline in the 10-City Composite HPI during the first half of this year to be about -1.75%. Following is the actual comparable figure, along with its component numbers:
Percentage Changes From Month to Month and Their Mean
In the 10-City Composite HPI Between January and June 2009
Source: Druids Investment Group (DIG) Table Based on S&P/Case-Shiller Data
By way of background, I note the 10-City Composite HPI dipped in every one of the 34 months between June 2006 and April 2009, as its value dropped from 226.29 to 153.20 (-32.30%).
On the one hand, I was completely unsurprised by the S&P/Case-Shiller data release on Jul 28 that showed a small increase in the 10-City Composite HPI during May. On the other hand, I was completely surprised by the data release on Aug 25 that showed a large increase in the same index during June. To me, the surprising aspect was not the direction but the magnitude of the change in the index from month to month.
There were three reasons why I anticipated comparatively positive reports for May (to a relatively lesser degree) and June (to a relatively greater degree), as follows:
-- The primary reason centered on the foreclosure moratoria carried out by major U.S. financial institutions voluntarily in the wake of their chief executive officers' testimony before Congress in February. Among these institutions were JPMorgan Chase & Co. (JPM), the Bank of America Corp. (BAC), and Wells Fargo (WFC). Although I neither am a real-estate maven nor play one on the Internet, my sense of the state laws governing foreclosures is that the process generally requires about 90 days (i.e., it is longer in some states and shorter in other states). Obviously, it is about 90 days from mid-February to mid-May.
-- The secondary reason centered on the first-time homebuyer tax-credit provisions of the above-referenced American Recovery and Reinvestment Act (http://tinyurl.com/d3d72m).
-- The tertiary reason centered on the seasonal patterns of home prices, as reflected by the following table:
Ranking of the Months of the Year by Mean Percentage Changes
From Month to Month in the 10-City Composite HPI Between 1987 and 2008
Source: Druids Investment Group (DIG) Table Based on S&P/Case-Shiller Data
Each of the three above-mentioned elements appears to account for some of the strength in U.S. home prices during the second quarter of this year, but none of them seems to account for all of it. Accordingly, I suspect excessive liquidity in the financial system may have been at work in the real-estate market over this period.
The Bottom Line
In the short term, the sharp inflation of a bubble sounds pretty good. In the long term, the sharp deflation of a bubble produces the kind of pop that is enduringly painful to the ears. Based on my interpretation of the 10-City Composite HPI and related data, I believe the U.S. real-estate market is still remarkably bubblicious, so I anticipate one hell of an earache -- eventually -- should home prices continue to significantly climb as they did in June.
On a couple of occasions elsewhere at P&P, I have recently discussed not only the primary blast of U.S. adjustable-rate-mortgage resets between the second quarter of 2007 and the third quarter of 2008 that blew away the Old World Economic Order (OWEO) last year but also the secondary gale of U.S. ARM resets from the second quarter of 2010 to the third quarter of 2011 that will hit the New World Economic Order (NWEO) next year.
As indicated during these discussions, I believe there may be key differences between these two events, as experienced by the NWEO, U.S. economy, and U.S. equity market. Using the Saffir-Simpson Hurricane Wind Scale as a metaphorical measuring device, I think the primary was a Category 5 event and the secondary may be a Category 3 event (in the worst-case scenario).
In my parsing of the relevant data sets, I see key differentiators as including but not limited to the following:
-- In terms of the amount of U.S. dollars involved in the ARM resets, the primary event featured seven months -- five of them contiguous -- when the total was estimated to be higher than the single worst forecasted month of the secondary event.
-- Bearing in mind both reset events involve six ARM categories -- Subprime, Alternative-A Paper, Prime, Agency, Option, and Unsecuritized -- there are major differences in each class's proportions during these two events. For example: In the case of the primary event, I believe Subprime ARM resets constituted the proximate cause of the demise of the OWEO; in the case of the secondary event, I think Subprime ARM resets may be a nonfactor in terms of the stability or instability of the NWEO. Moreover, I anticipate Agency ARMs may directly cause either little or no stress on the economy in the foreseeable future. However, the Alt-A, Option, and Prime ARM categories may be pretty problematic.
-- Because of its change in administration this year, the U.S. government has abandoned its Hear-No-Evil, See-No-Evil, Speak-No-Evil approach to the economy and the financial markets. Accordingly, I suspect the above-referenced American Recovery and Reinvestment Act, Financial Stability Plan, Homeowner Affordability and Stability Plan, and other initiatives all may have borne fruit by the time of the secondary ARM-reset event.
-- Although I believe there is a significant risk of a U.S. double-dip recession, I also think there is a high probability the past contraction ended and the present expansion began in the second half of this year, as well as an intermediate probability it happened this month, as suggested in On the U.S. Economy and Equity Market (http://tinyurl.com/msvsvv).
-- On the one hand, I see the primary ARM-reset event as having occurred while U.S. home prices were plunging. On the other hand, I see the secondary ARM-reset event as occurring while U.S. home prices may be more or less stable. However, a fresh bout of bubbliciousness in the real-estate market could lead to this potential stability being a comparatively short-lived phenomenon.
Related Blog Posts
Alternative U.S. Realty Realities, Take 1
http://tinyurl.com/n7yw39
Alternative U.S. Realty Realities, Take 2
http://tinyurl.com/lhvqln
Alternative U.S. Realty Realities, Take 3
http://tinyurl.com/kwv9wf
