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Special Report: Extended S&P/Case-Shiller futures debut
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PostPosted: Tue Sep 18, 2007 2:50 am GMT    Post subject: Special Report: Extended S&P/Case-Shiller futures debut Reply with quote

Today was historic because it marked the debut of several new S&P/Case-Shiller futures contracts. Previously, futures contracts were available for predicting and hedging against changes in housing values for up to roughly one year into the future. As of today, futures will be available for up to five years into the future. This provides unprecedented opportunities in a myriad of ways, but readers of this site may currently be most interested in the opportunity to get probably the most unbiased prediction of where the housing market will be in the Boston area several years into the future. The futures markets are particularly unbiased because there is quite a bit of money to be made from being accurate, as opposed to other sources which have an intrinsic incentive to be inaccurate.

After the very first day of trading, here is what the futures contracts predict for the Boston housing market, provided I calculated things correctly (see below):



Please note: I have not traded futures contracts before, and so I am not entirely certain that the value of the futures contracts can be used as-is for the implied future value of the index. They might need to be adjusted to account for trading expenses (possibly including the opportunity cost of margin). If anybody reading this has experience trading cash settled futures, your input would be appreciated.

The rest of this post will be predicated on the assumption that the values of the futures can be used as-is.

The most immediately striking revelation provided by the futures data is that there is no end in sight to the current housing downturn. The data extends all the way to September 2011 and it is downhill all the way. Bottom line: be very skeptical of claims that prices are going to turn around and start going back up anytime in the near future - while that may be possible, the market is predicting that a protracted decline is the more likely scenario.

As for the magnitude of the decline, the implied value for the index on September 2011 indicates an expected total decline of at least 29.40% in nominal prices from the nominal peak set in September 2005. That would also be a 21.49% nominal decline from the most recent month currently covered by the S&P/Case-Shiller Index (June 2007). Please note that these declines are not adjusted for inflation and would be larger and more accurate if they were. Inflation was not factored out due to time constraints. Also note that the total expected decline may actually be greater than 29.40% since the futures do not presently show a clear bottom and only extend a finite number of years into the future.

One major caveat to be aware of is that the volume on these futures contracts is pretty low right now. Consequently, they probably aren't a particularly good predictor of future prices just yet. Nevertheless, other predictors are even less reliable.

The source data used for the above report was obtained from:

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PostPosted: Tue Sep 18, 2007 1:14 pm GMT    Post subject: Another Japan? Reply with quote

This is looking like the Japan real estate bubble. I wonder if this decline will extend past a decade? That would place the bottom at around 2015. Ouch!

I think we'll keep renting in Boston. Our rent is low. Our place is big. Our location is great. There is no rush to buy.
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PostPosted: Tue Sep 18, 2007 3:40 pm GMT    Post subject: Reply with quote

Admin,

Nice stuff. I don't know if it's too much work, but it would be nice to keep track of future values over time and then compare to see how predictive these numbers actually are.

With the low volume, I'm a little concerned that the low value is really a measure of demand for the future itself rather than a predictor of future value. Although I do agree that the futures are a less biased source than, say, the MAR.
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PostPosted: Tue Sep 18, 2007 5:08 pm GMT    Post subject: Reply with quote

JCK wrote:
I don't know if it's too much work, but it would be nice to keep track of future values over time and then compare to see how predictive these numbers actually are.


I have been trying to do this, actually. I missed the last contract expiration, I think because some spam filter ate the email reminder I had set up for myself in Yahoo! Calendar. I have also tried looking for historical data for the futures but so far haven't found any, so the best method I have at present is to visit FutureSource.com on the day of the settlement and print the graph before the contract is removed from their listing.

JCK wrote:

With the low volume, I'm a little concerned that the low value is really a measure of demand for the future itself rather than a predictor of future value. Although I do agree that the futures are a less biased source than, say, the MAR.


I'm not sure that the value of the contract is swayed in a particular direction due to low volume in and of itself. I thought that how it works (and I could definitely be wrong) is that when a futures contract is entered between two parties, the money doesn't actually change hands until the settlement date, and even then the amount changing hands is only the difference between the predicted value and the actual value. Now, the parties may need to put up some margin to assure the brokerage that they will be able to cover the difference at settlement, but this is typically a small percentage of the overall value and in the case of the S&P/CSI futures, the margin amount appears to be independent of the contract value. Currently, it looks like the margin requirement is fixed at $1,688:

http://www.cme.com/html.wrap/wrappedpages/clearing/pbrates/PBISOutrightH.htm?h=2

However, like I said, I haven't actually traded futures before, so I might be misconstruing some things.

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john p



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PostPosted: Tue Sep 18, 2007 6:10 pm GMT    Post subject: Reply with quote

What is the difference between the purple portion labeled BOXR and the red portion labeled Implied BOXR. What is BOXR?
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PostPosted: Tue Sep 18, 2007 6:15 pm GMT    Post subject: Reply with quote

john p wrote:
What is the difference between the purple portion labeled BOXR and the red portion labeled Implied BOXR. What is BOXR?


BOXR is the symbol used for the Boston S&P/Case-Shiller index in the spreadsheet provided by S&P (above).

The purple portion represents actual past values of the index. The red portion represents the expected future values of the index based on the futures contracts.

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PostPosted: Tue Sep 18, 2007 7:28 pm GMT    Post subject: Reply with quote

Sorry if I don't get it, but what do the numbers 60 to 190 on the right represent? Is that like a dollar per share or something?
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PostPosted: Tue Sep 18, 2007 7:28 pm GMT    Post subject: Reply with quote

I meant the numbers on the left....
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PostPosted: Tue Sep 18, 2007 7:44 pm GMT    Post subject: Reply with quote

john p wrote:
Sorry if I don't get it, but what do the numbers 60 to 190 on the right represent? Is that like a dollar per share or something?


The numbers on the left are the values of the S&P/Case-Shiller Index for Boston and are a relative measurement of housing prices in the area. The values are meant to be compared against each other in time and aren't terribly useful in isolation. Although... the scale is normalized such that January 2000 equals 100, so I suppose you could think of the index value X as being X% of January 2000 prices in nominal dollars. More generally, the percentage change of the index between two times is supposed to reflect the percentage change in housing prices for the area over that same time period. Hopefully I didn't just make things more confusing.

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PostPosted: Tue Sep 18, 2007 8:07 pm GMT    Post subject: Reply with quote

I know I'm like the Bill Murray character in Ghostbusters, but could you give me a couple of inputs i.e. what was the median price in January 2000 and how that is 100 and then say what is July 2007 median price and corresponding number (170). From what you said earlier the jump from 100 in the year 2000 to 180 in 2006 is an 80 percent increase in house price?

So this is saying that the market will decline 10 percent a year for 3 straight years?

Is this tool about measuring the real market confidence?

I would imagine that this might have some connectivity with other alternative investments i.e. if stocks are tanking, these might look like a safe place to park your money, so money might come in and out of this depending on what other investments are hot or cold.

I would think that this is like the stock price not being exactly tied to the P/E ratio of a company; strongly connected but not exactly tied (a bit of weight on projections of confidence of future performance)
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PostPosted: Tue Sep 18, 2007 8:38 pm GMT    Post subject: Reply with quote

john p wrote:
I know I'm like the Bill Murray character in Ghostbusters, but could you give me a couple of inputs i.e. what was the median price in January 2000 and how that is 100 and then say what is July 2007 median price and corresponding number (170).


They don't actually use the median since that is subject to several distortions, such as a change in the size of what is being bought. The details of the methodology are here:

http://www2.standardandpoors.com/spf/pdf/index/SPCS_MetroArea_HomePrices_Methodology.pdf

john p wrote:

From what you said earlier the jump from 100 in the year 2000 to 180 in 2006 is an 80 percent increase in house price?


Yes, that's correct, except that it was at 180 in the tail of 2005.

john p wrote:

So this is saying that the market will decline 10 percent a year for 3 straight years?


Part of the 29.40% decline has already occurred. The futures are predicting an additional 21.49% decline over the course of the next 4.25 years. That works out to an annual decline of 5.53%

john p wrote:

Is this tool about measuring the real market confidence?


I think its more about betting where prices will be. In fact, I have never understood why this is legally different from gambling.

john p wrote:

I would imagine that this might have some connectivity with other alternative investments i.e. if stocks are tanking, these might look like a safe place to park your money, so money might come in and out of this depending on what other investments are hot or cold.


I think there are two main reasons to buy these futures contracts: 1) to hedge against price declines (or increases) or 2) because you think that the hedgers got the price wrong and can profit from the difference. It's essentially a democratized housing price insurance vehicle.

john p wrote:

I would think that this is like the stock price not being exactly tied to the P/E ratio of a company; strongly connected but not exactly tied (a bit of weight on projections of confidence of future performance)


Well, if there is an inherent bias in the prices (and maybe there is), then you can profit from that. I have been contemplating this myself.

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PostPosted: Tue Sep 18, 2007 9:41 pm GMT    Post subject: Reply with quote

That link absolutely rocks.

http://www2.standardandpoors.com/spf/pdf/index/SPCS_MetroArea_HomePrices_Methodology.pdf

Check out pages 24, 26 and 27.

page 24: real estate seems to be in step with incomes; equities all over the place.

Page 26: things haven't been fundamentally balanced since 1986

Page 27: you can see the impact of interest rates on house prices.

This site is gold.
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PostPosted: Wed Sep 19, 2007 12:17 am GMT    Post subject: Hard to draw conclusions Reply with quote

I think you should wait at least a few days before making predictions. If you examine the contracts that have been around for awhile you'll notice that there is a lot of volatility in them overtime. The Nov. 2007 contract price, for instance, has flutuated between 159-169 in the past year. Interestingly, it has been steadily moving up since April. Not sure if you should draw a conclusion from that but the outlook at least in the short-term seems less gloomy than in was in April. Likewise with the Feb. 2007 report. which was once at 157 and now is up at about 165. So basically, a few months ago the prediction was that the price declines it now predicts to occur over two years to occur by February. You can also tell that there has been exactly one contract for many of these periods and only a few more for others... The reliability of this index is about the same as me making a prediction or you making a prediction. It is basically just the opinion of one person. It also doesn't surprise me that it has a downward trajectory because most of the people who seem to think they know how much (i.e. what %) the market will move are also those who are 100% certain that the market is going to crash.
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PostPosted: Wed Sep 19, 2007 1:04 am GMT    Post subject: Re: Hard to draw conclusions Reply with quote

Anonymous wrote:
I think you should wait at least a few days before making predictions. If you examine the contracts that have been around for awhile you'll notice that there is a lot of volatility in them overtime. The Nov. 2007 contract price, for instance, has flutuated between 159-169 in the past year. Interestingly, it has been steadily moving up since April. Not sure if you should draw a conclusion from that but the outlook at least in the short-term seems less gloomy than in was in April. Likewise with the Feb. 2007 report. which was once at 157 and now is up at about 165. So basically, a few months ago the prediction was that the price declines it now predicts to occur over two years to occur by February. You can also tell that there has been exactly one contract for many of these periods and only a few more for others... The reliability of this index is about the same as me making a prediction or you making a prediction. It is basically just the opinion of one person.


I don't see how waiting a few days would make a difference, unless you were planning to average or otherwise combine all past values, which I don't think would be any better than always using the latest value. The two contracts you picked as examples are actually not too far from where they started. Yes, they both took dips at one point, but you only would have gotten to those dips if you actually had waited. I'm not saying that the prediction is particularly reliable, just that it isn't going to get any better by waiting.

Anonymous wrote:

It also doesn't surprise me that it has a downward trajectory because most of the people who seem to think they know how much (i.e. what %) the market will move are also those who are 100% certain that the market is going to crash.


I doubt this. Have you read anything put out by the NAR? They sure sound certain.

Also, anybody who acts 100% certain of things is probably just acting. You need to put some serious money where your mouth is to purchase a futures contract. That helps to weed out actors (or at least educate them).

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PostPosted: Wed Sep 19, 2007 12:26 pm GMT    Post subject: Reply with quote

I'd really be curious to see what these future were predicting in 2004 and 2005.

Also keep in mind that future values are necessarily discounted, because, if you purchase the future, you can't invest the same money elsewhere. In that sense, the future value may already be effectively "inflation adjusted," even if you're the betting itself is on the nominal price. The "correct" value for the future would be the predicted nominal price minus the opportunity cost of tying up you money for, say, five years, as opposed to investing in stocks, a certificate of deposit, etc.

This would also be consistent with Guest's observation that the Nov 2007 value has gone up as we have gotten closer to that date.
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