Hot housing market isn't a risk to the U.S. stock market


U.S. real estate prices have risen consistently throughout 2017. The S&P/Case-Shiller U.S. National Home Price Index continues to make highs that exceed that of 2007.

Whenever a headline states “U.S. housing prices are now above that of 2007”, it brings back terrible memories. These headlines are essentially saying “The last housing bubble killed the U.S. economy and stock market. U.S. housing is in a bubble right now. So housing will kill the economy and stock market this time.”
Here’s why the hot U.S. housing market isn’t a risk to the U.S. stock market.

There is a difference between “hot” and “a bubble”

Is the U.S. housing market hot? Yes. Various housing indexes all demonstrate that U.S. housing prices are on the rise. You may even argue that some areas of the U.S. are in a bubble (e.g. San Francisco). But as a whole, U.S. housing is not in a bubble.
For starters, it’s been 10 years since 2007. Nominal home prices would be going up based on inflation alone! So there’s nothing surprising about the S&P/Case-Shiller Index making new all-time highs that exceed 2007.
This is what happens when you adjust the Housing Index by CPI (inflation).

U.S. housing is cheaper than in 2006/2007 when adjusted for inflation. This makes sense. The S&P/Case-Shiller peaked at 184.62 in July 2006. The Index is at 195.63 today.

  1. The Index has gone up 6% since 2006.
  2. U.S. CPI has gone up 22% since 2006!

You can also measure how “hot” a housing market is by its year-over-year price increase.
Here are the year-over-year increases for various housing indexes. Focus on “U.S. National”.

Notice that the U.S. National Index is increasing at a MUCH SLOWER pace today than in 2005-2006. In fact, the year-over-year percent change is barely creeping higher.
Now this doesn’t mean that individual cities aren’t seeing bubbles proportionate to the last housing bubble.
Here’s Seattle.

Meanwhile, other cities are seeing price increases FAR BELOW that of the last housing bubble. Here’s Sin City (Las Vegas).

So even if there is a “housing bubble” (as some permabears would call it), the “bubble” is much less widespread than it was pre-2007.
This is merely a hot housing market, which is normal for the final quarter of any economic expansion. The last housing bubble was nation-wide. Today, the housing bubble is more confined to a few large cities. There is no nation-wide bubble.
*Based on current data, our Medium-Long Term Model states that the current bull market in U.S. stocks has 2-3 years left.

No “bubble” in housing volume

A “bubble” is defined by 2 criteria

  1. The year-over-year price increase going exponential.
  2. A surge in volume.

The last housing bubble caught the public’s imagination. Housing volumes soared. Today, volumes are lackluster. Look no further than New Home Sales, which are almost half of 2005’s and 2006’s levels.

The hot housing market won’t kill the stock market

Here’s a layman’s version of what really happened in 2008.

  1. The housing bubble burst. Prices fell, and millions of Americans defaulted.
  2. The banks were highly leveraged. They bought a lot of these mortgage bonds for their own books.
  3. Due to their leverage, these banks went under as American mortgages defaulted.
  4. The destruction of U.S. banks killed the U.S. credit markets (no one willing to lend money to businesses). U.S. corporate loan volume tanked 9% in June 2008 alone.
  5. With businesses unable to borrow money, the U.S. economy and stock market tanked.

All of this could have been avoided if the banks weren’t so highly leveraged. By being highly leveraged, the banks turned an isolated problem (U.S. mortgages and the housing market) into a full-scale crisis.
Banks have much less leverage and exposure to the housing market today. They are much safer and less prone to systematic risk.
*Banks can sit through a storm and avoid a “bank run” if they have more cash and less leverage. Investment banks can wait until their asset prices rebound instead of selling at fire-sale prices.

  1. The ratio of Goldman’s assets to cash today is 9.78!
  2. The ratio of Bank of America’s assets to cash today is 7.38!
  3. The ratio of JPMorgan’s assets to cash today is 8.2!
  4. The ratio of Citigroup’s assets to cash today is 7!

Many of Wall Street’s largest banks had ratios of 30:1 or 40:1 in 2007!
This is an older chart, but illustrates the point quite nicely. U.S. banks are sitting on record amounts of cash.

So unless

  1. the U.S. housing market tanks, and…
  2. U.S. banks face significant problems…

the hot U.S. housing market is not a risk to the U.S. stock market in 2018. Neither of these risks are present right now.

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