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S&P/Case-Shiller Boston Snapshot: Nov 24, 2009

 
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PostPosted: Fri Nov 27, 2009 4:27 am GMT    Post subject: S&P/Case-Shiller Boston Snapshot: Nov 24, 2009 Reply with quote

On Tuesday, November 24th, Standard & Poor's released the S&P/Case-Shiller housing price index data for September 2009. Boston area single family home prices fell 3.33% from one year earlier, in nominal terms.

The November 2009 futures contracts for the index, which cover prices in the third quarter of 2009, were also settled on the same day. When the extended S&P/Case-Shiller futures were first introduced, Mike suggested that somebody archive the predictions of the futures contracts, and I proposed that a good time to do that would be each day that a futures contract is settled (i.e., quarterly). This post is an attempt to provide such a time capsule for the future.

Below are two graphs of the S&P/Case-Shiller Index for Boston from 1987 through the present (shown in solid purple), with the expected future values added using the values of the futures contracts on the indicated dates:





The market is pricing in the following with respect to nominal housing prices through 2013 Q3:

  • An additional decline from the most recent month of 7.60% by 2010 Q3.
  • A total decline from the peak of 21.18%
  • Essentially flat nominal prices from the bottom through 2013 Q3, which is as far as the futures go.

The market expectation implied by the closing values of the futures contracts on November 24th is that nominal prices have temporarily bounced off of the bottom, will return there over the coming months, and will then remain flat for as far into the future as contracts are available. Prices had previously arrived at the level predicted as the bottom by several of the past futures snapshots, but they did so earlier than predicted. Their bounce above previously predicted levels is quite possibly the result of the temporary home buyer tax credit.

Of course, flat nominal prices imply falling real prices when inflation is present, and it is. In past reports before November 25, 2008, the futures contracts were corrected for inflation using the adjusted 10-year TIPS-derived expected inflation published by The Federal Reserve Bank of Cleveland. Unfortunately, they discontinued publication of this series on October 31, 2008 citing an "extreme rush to liquidity" as making the estimates no longer accurate. Consequently, future inflation from then on has been estimated using the yield on 5 year Treasuries. Suggestions for an improvement on this estimate are welcomed and encouraged.

Here is the same housing data adjusted for inflation, expressed as a percentage of real prices from the most recent month:





The market is pricing in the following with respect to real housing prices through 2013 Q3:

  • An additional decline from the most recent month of 13.59%
  • A total decline from the peak of 33.86%.


There was a strong month over month spring and summer bounce this year, bringing the housing price index value from the bottom to beyond the top of the range predicted in past snapshots and providing ample fodder for the media to proclaim that the bottom has been hit. However, it is quite plausible that this bounce was artificial and temporary thanks to the temporary $8,000 US tax credit for home buyers. At the most basic level, it plausibly added $8,000 to the price of homes near the Massachusetts median. However, its side effects may have been just as important, if not more so, in producing the appearance of a particularly large spring bounce. The tax credit in conjunction with the Massachusetts program to facilitate its use as a down payment surely expanded the pool of potential buyers to people who would have otherwise not been able to buy due to an insufficient down payment. In fact, the increased demand from people rushing to not miss out on $8,000 in savings could very well have (artificially) bid prices up by quite a bid more than $8,000 because of all the extra buyers.

The tax credit also probably caused a time shift of home purchases which would have been made anyway, pulling demand from the beginning of 2009 as well as next year and swelling demand this spring, summer, and fall. Depressed demand in the winter would have lowered prices there and increased demand in the spring and summer would have increased prices there, and so the apparent rise from winter to summer is artificially steepened. Finally, those who purchased before the credit took affect may have mentally discounted their offer prices to make up for the credit they would be missing.

Strong evidence for this hypothesis can be seen in the tiered S&P/Case-Shiller Index for Boston. The bounce is very pronounced in the low tier, where the credit would have the most impact, and practically absent in the high tier, where it would be a smaller percentage of the price and where many buyers would have been presumably disqualified from the credit due to the associated income limits.





In fact, the Massachusetts Association of Realtors attributed the recent "improvement" in prices (i.e., declines that aren't as steep usual) and increase in sales volume to the home buyer tax credit:
Quote:

"We really feel that the past three months of positive home sales are a result of the $8,000 tax credit and its impending expiration date," said MAR President Gary Rogers, a broker with RE/MAX First Realty in Waltham. "Despite this bump, we are concerned that it will take longer and be more difficult for the market to stabilize without extending the Federal tax credit for homebuyers past the December 1 deadline."

In essence, recent data does not demonstrate stabilization, it does not demonstrate a bottom, it only reflects government life support. If the market had truly hit bottom, there would be no need for continued government intervention. (Which isn't to say that there is a "need" for it pre-bottom either, just that calls for help with "stabilization" are pointless if stabilization already exists.) While the begging of such industry groups did end up working to extend and expand the expensive and fraud riddled pork, it may produce diminishing returns once the year over year numbers no longer reflect increasing intervention and because many purchases have already been time shifted.

It will be extremely interesting to see how the extended and expanded tax credit impacts home prices in the Boston area. Continued price "stabilization" might require not just continued government intervention, but continually increasing levels of intervention. This most recent extension of the credit delivers in that regard in that it expands the credit to also be a handout to high income buyers and existing owners. However, the expansion to include existing owners could potentially end up lowering Boston area prices by encouraging current owners to take this as an $8K incentive to move to a lower cost area. It will be very interesting to see which dynamic prevails.

Additionally, it may only be a matter of time before the tax credit backfires in creating the sense of urgency which is essential to producing the illusion of demand. Remember, this incentive started as an interest free loan that eventually needed to be repaid. Then it was expanded to be a straight handout. Now it has been expanded once again to be a handout to the wealthy and existing homeowners. If the credit keeps being extended and expanded, that actually produces an additional incentive to wait to buy because the handout will be so much better later.

Another interesting question is how many buyers have been tapped out already? Did the intermediate tax credit already time shift into spring and summer 2009 most marginal demand that could be stimulated? The credit is a huge wild card and it is inadvertently stimulating a great deal of uncertainty.

Note that the volume on the futures contracts is currently very sparse, and so using them to predict future housing prices should be viewed as unreliable. However, bear in mind that other sources of predictions are most likely even less reliable, especially organizations like The NAR which have a disincentive for accuracy. The futures markets are probably the least biased predictor available, given that those trading the contracts have a direct financial incentive to be accurate (real money rides on the accuracy).

Also note that the contract values might not necessarily reflect the expected value of the index if there are unaccounted opportunity costs involved. This was discussed in some detail in the original thread when the extended futures debuted. It is my current understanding that both the buyer and seller would have the same opportunity costs (a performance bond and transaction costs), and these costs would therefore offset each other when viewing the value as predictive. This could be wrong, though. If you would like to discuss this point, please read the original thread first since there are some references there to support the assumption of symmetry.

The settlement data for the futures contracts on the 24th was:

  • Nov '09 155.62
  • Feb '10 156.00
  • May '10 154.00
  • Aug '10 148.00
  • Nov '10 143.80
  • Feb '11 143.80
  • May '11 143.80
  • Nov '11 148.40
  • May '12 146.00
  • Nov '12 144.40
  • Nov '13 146.00

Previous snapshots are available for:

Please do try this at home, in order to bring to light any errors. The data used for the above report was obtained from the following sources:

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The latest version of this report can be found at http://www.bostonbubble.com/latest.php?id=spcsi_bos_snapshot

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PostPosted: Tue Dec 22, 2009 2:06 pm GMT    Post subject: Question about nominal vs real Case Shiller Future price Reply with quote

Admin - when you apply 5yr Treasury yield, have you bootstrapped the yield curve before applying or have you applied the yield for every year?
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PostPosted: Tue Dec 22, 2009 2:17 pm GMT    Post subject: Re: Question about nominal vs real Case Shiller Future price Reply with quote

CL wrote:
Admin - when you apply 5yr Treasury yield, have you bootstrapped the yield curve before applying or have you applied the yield for every year?


I made no adjustments and used the 5 year yield directly from http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml Can you tell if those numbers are bootstrapped? I would guess that they are since there are no coupons listed.

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PostPosted: Tue Dec 22, 2009 3:56 pm GMT    Post subject: Reply with quote

I think, unless specified, all Treasury with maturity over 1 year have coupons. Don't think the government will bootstrap the yield curve for you (will be nice though).

Say if you just look at 2010, are you applying 2% inflation expectation when 1 year Treasury for next year is essentially 40bps?
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PostPosted: Tue Dec 22, 2009 4:21 pm GMT    Post subject: Reply with quote

CL wrote:
I think, unless specified, all Treasury with maturity over 1 year have coupons. Don't think the government will bootstrap the yield curve for you (will be nice though).


But they don't list the coupons on that page. Wouldn't the yields listed be completely useless if they aren't bootstrapped, given that no coupons are listed and given that the quoted yields aren't from actual issues (they're interpolated from composites)?

CL wrote:

Say if you just look at 2010, are you applying 2% inflation expectation when 1 year Treasury for next year is essentially 40bps?


Yes. Maybe I should use more of the yield curve next time. That wouldn't change the 2013 numbers, though, which are are of more interest than 2010 (with respect to inflationary impact).

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PostPosted: Tue Dec 22, 2009 4:31 pm GMT    Post subject: Reply with quote

I just checked on Bloomberg and the yield are indeed Treasury with coupons - 30 years yield 4.56 as of 12/21 have 4.25 coupon rate, paid bi-annually.

Your 2013 numbers will likely change if you use the whole yield curve bootstrapped instead of just one point estimate for the whole 5 years period. There should be some bootstrapping excel spreadsheet floating around internet should you need one.
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PostPosted: Tue Dec 22, 2009 5:01 pm GMT    Post subject: Reply with quote

CL wrote:
I just checked on Bloomberg and the yield are indeed Treasury with coupons - 30 years yield 4.56 as of 12/21 have 4.25 coupon rate, paid bi-annually.


I'm sorry, I'm still not following. I think that you're saying that the numbers should be bootstrapped so that the coupon is accounted for. However, the coupon seems to already be accounted for. Isn't the quoted 4.56 yield the annual return you can expect by holding to maturity, with all things considered, including coupon and price? That is consistent with the latest numbers from Bloomberg. Am I misunderstanding what you're saying?

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PostPosted: Tue Dec 22, 2009 6:47 pm GMT    Post subject: Reply with quote

An explanation for bootstrapping will be a bit too long for posting, so I post a link instead from Investopedia:

http://www.investopedia.com/university/advancedbond/advancedbond4.asp

The main problem is to get an proxy for inflation from interest rate, you need to take the term structure into account instead of using an arbitrary point estimate (5 year Treasury yield in your case). Lemme know if you need more info.
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PostPosted: Tue Dec 22, 2009 8:37 pm GMT    Post subject: Reply with quote

Thanks for the link. I do see the value in bootstrapping, though I'm still fuzzy on how to apply it to an inflation estimate. Correct me if I'm wrong, but you would want to bootstrap when committing your savings to Treasuries for five years because the periodic coupon payments would need to be reinvested in Treasuries of shorter maturities and differing yields. However, if you remove the requirement that the saving be available in its entirety again in five years and instead perpetually reinvested the coupons into new five year issues, wouldn't that also address the issue without the need for bootstrapping? I don't know that there's a reason to assume to the rate of return for savings tied up for exactly five years is any better an estimate for inflation than the rate of return for savings perpetually tied up for revolving 5 year windows.

I chose five years as the time frame because the S&P/Case-Shiller futures look up to five years into the future. So it wasn't an arbitrary point, but maybe it wasn't the best point. If you can make a case for some other point, I'm listening. Are you suggesting that I not use a single inflation estimate but instead use the entire bootstrapped yield curve as the expectation of inflation over time? I'd be hesitant to do that because I don't think that the upward slope of the yield curve is fully attributable to an expectation that inflation will increase over time - the real yield curve from TIPS slopes upward too.

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PostPosted: Wed Dec 23, 2009 2:12 pm GMT    Post subject: Reply with quote

The explanation will involve a lot more back-and-forth, so let me email you instead of posting here.
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