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S&P/Case-Shiller Boston Snapshot: Feb 26, 2008

 
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PostPosted: Wed Feb 27, 2008 9:35 pm GMT    Post subject: S&P/Case-Shiller Boston Snapshot: Feb 26, 2008 Reply with quote

On Tuesday, February 26th, Standard & Poor's released the S&P/Case-Shiller housing price index data for December 2007. Boston prices fell 3.4% from one year earlier, in nominal terms, as previously reported (Info/Broken?).

The February 2008 futures contracts for the index, which cover prices in the fourth quarter of 2007, 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 is a graph 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 Q3 2012:

  • An additional decline from the most recent month of 9.72%.
  • A total decline from the peak of 18.55%.

The expected dip that has appeared for this spring in fact just materialized on the 26th when the May '08 and Aug '08 contracts fell 8.00 and 3.00 points respectively after an extended period of relative inactivity. The other unsettled contracts were unchanged. Whether the other contracts see similar adjustments remains to be seen, although it is possible that the market expectation is now that the biggest price drops are coming this spring and that nominal prices will stay somewhat flat for several years thereafter.

Of course, flat nominal prices imply falling real prices when inflation is present (and it is). Here is the same data adjusted for inflation using the Bureau of Labor Statistics' CPI-NU series and the adjusted 10-year TIPS-derived expected 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 Q3 2012:

  • An additional decline from the most recent month of 20.65%
  • A total decline from the peak of 33.53%.


Note that the volume on these 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 26th was:

  • Feb '08: 164.59
  • May '08: 152.00
  • Aug '08: 157.00
  • Nov '08: 153.00
  • Feb '09: 157.60
  • May '09: 155.40
  • Nov '09: 151.00
  • May '10: 148.60
  • Nov '10: 150.00
  • Nov '11: 150.00
  • Nov '12: 152.80

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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PostPosted: Thu Feb 28, 2008 6:06 pm GMT    Post subject: Excellent analysis... Reply with quote

As usual...

Its interesting, I think, to see that at the moment traders are expecting a correction that in some respects would be fairly typical.... roughly a 34% "real" decline peak to trough.

In a historical sense, this is not unprecedented and would certainly not be surprising.

I wonder how the notion of recession will effect prices from here on and whether when the recession materializes as an factual headline event (NBER declares recession then splashed all over every media source) we will see pricing reflect a larger more unprecedented correction.

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PostPosted: Thu Feb 28, 2008 10:26 pm GMT    Post subject: Reply with quote

Intrade is currently selling a futures contract on whether the US economy will enter a recession in 2008 (it's at 63.4% probability, for the curious). It will be interesting to see if swings in that contract correlate with the far looking Case-Shiller futures. The Case-Shiller futures volume is too low to tell, at this point.

I have to wonder if the recent drop in the contracts for the first half of this year is in response to the anemic volume of home sales so far this year. The drop did come on the heels of The MAR's January data. I also wonder whether the fact that it was limited to the May '08 and Aug '08 contracts is of any significance.

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PostPosted: Fri Feb 29, 2008 1:26 pm GMT    Post subject: Questions Reply with quote

I suspect the liquidity issue here is making things a little worse than likely, but would also point out that there is a cost of carrying these contracts. No one is going to buy a futures contract for any asset if it without taking into account time value of money. If short-term risk free rates are currently around 2% (2-yr Treasuries and we assume they stay there), then over the course of the next three years, you'd demand 1.02^3 to be compensated for your investment...so in nominal terms you'd want an extra 6.1% on top of the "discount" to current implied values for housing, which would make this seem worse....or am I crazy?

Any chance of someone tracking this in aggregate for the US as a whole? I haven't seen that anywhere?
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PostPosted: Fri Feb 29, 2008 1:32 pm GMT    Post subject: Reply with quote

Miles,

There has been some exploration of this very issue on the board. I guess the question, is how much money do you have to tie up relative to your potential payoff, assuming you bet correctly? And how would this affect the predictions one would make on housing prices?

I'm still a little unclear on that aspect of these futures.

Admin had some thoughts that discounting future value wouldn't have a significant effect the future prices, but personally, I'm pretty hazy on the actually mechanics of how these things are bought and sold.
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PostPosted: Fri Feb 29, 2008 1:57 pm GMT    Post subject: Reply with quote

Yes, there is in opportunity cost for the individual buying or selling the contract, but there is an equal opportunity cost for the person on the other side of the transaction, so I would think that the costs cancel each other out when viewing the value as predictive. The buyer pays a little less than he would have if there were no money tied up, but the seller sells for a little more for the same reason. The average expectation is what gets reported as the contract value.

The individual's opportunity cost is also much lower than 6.1%. This was covered in more detail in the original thread (be sure to click on the link for the second page).

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JCK



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PostPosted: Fri Feb 29, 2008 4:15 pm GMT    Post subject: Reply with quote

Admin,

Who is the person on the other side? I'm having a lot of difficulty visualizing how these options work in practice.

For example, if I buy an option for May 2008, who am I buying it from? And, if I buy their option, aren't they out of the game completely? I'm not seeing how the opportunity costs cancel out.

Finally if I buy this option, how much to I have to pay, and what are my potential payoffs?

Oil futures by contrast seem very straightforward. If I have a May 2008 option on oil for 100 barrels of oil for $95/barrel, I am obligated to buy 100 barrels of oil at that price and time. I also understand that if oil is $100/barrel for example, I can sell my option at $100/barrel, and make $5/barrel.

But with these "futures" there's no physical commodity, so I'm having a bit more difficult understanding the mechanics and the parties involved. With oil, the oil companies can sell the options on their future production. With this, who is the mysterious seller of options?
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PostPosted: Fri Feb 29, 2008 4:47 pm GMT    Post subject: Reply with quote

Quote:

Who is the person on the other side? I'm having a lot of difficulty visualizing how these options work in practice.


You're right, there is no commodity changing hands here. Maybe it would help to think of it as buying and selling a "bet." You don't need to own anything (other than cash) to say "I will pay you $250 for every point that the index is above X on the settlement date," but that would make you the "seller" in the contract. The "buyer" takes the side of the bet that benefits if the index goes up more than predicted and the "seller" takes the side that benefits if the index goes down.

You have to post a "performance bond" to place a bet, and that applies regardless of which side of the bet you are taking. It is currently $1,688 for Boston and the latest value can be found at http://www.cme.com/html.wrap/wrappedpages/clearing/pbrates/PBISOutrightH.htm?h=2 The foregone interest on that bond is the symmetric opportunity cost (assuming you don't make interest on it - perhaps you do). You need two parties, one for each side of the bet, and they are both tying up $1,688 to play. The value of the contract is settled at the index value times $250, so you would make (or lose) the difference between the futures value and the eventual index value, times $250.

The CME's brochure on the contracts is at:

http://www.cme.com/files/cmehousing_brochure.pdf

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JCK



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PostPosted: Fri Feb 29, 2008 6:30 pm GMT    Post subject: Reply with quote

admin wrote:
Quote:

Who is the person on the other side? I'm having a lot of difficulty visualizing how these options work in practice.


You're right, there is no commodity changing hands here. Maybe it would help to think of it as buying and selling a "bet." You don't need to own anything (other than cash) to say "I will pay you $250 for every point that the index is above X on the settlement date," but that would make you the "seller" in the contract. The "buyer" takes the side of the bet that benefits if the index goes up more than predicted and the "seller" takes the side that benefits if the index goes down.

You have to post a "performance bond" to place a bet, and that applies regardless of which side of the bet you are taking. It is currently $1,688 for Boston and the latest value can be found at http://www.cme.com/html.wrap/wrappedpages/clearing/pbrates/PBISOutrightH.htm?h=2 The foregone interest on that bond is the symmetric opportunity cost (assuming you don't make interest on it - perhaps you do). You need two parties, one for each side of the bet, and they are both tying up $1,688 to play. The value of the contract is settled at the index value times $250, so you would make (or lose) the difference between the futures value and the eventual index value, times $250.

The CME's brochure on the contracts is at:

http://www.cme.com/files/cmehousing_brochure.pdf

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So the opportunity cost for these contracts is very different from oil futures. I see what you mean by "canceling out" now.
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PostPosted: Fri Feb 29, 2008 6:55 pm GMT    Post subject: Reply with quote

In the spirit of "opportunity costs", think about taking your eye off the ball.

For instance, if say, in the 1990's, early 2000's people would say to themselves, there is so much potential to make money that I'm going to pay attention to my work and not bother delve into the deep dive and explore every nook and crannie to save an extra $20k on a house.

Opportunity costs are investments of time and in a declining economy people look less towards moving the top line and more towards tightening their belt in spending. The result of this is that people pay attention more to things.

My question to you guys is why spend the time to follow an asset class (housing futures) that is so fickle? I think that this could make sense as a hedge against something else to balance assumptions and dampen a wrong prediction. I get that if you have a heightened sensitivity and elevated knowledge and deep experience that you'd have the upper hand in making the right assumptions, but this is the future we're talking about. I'd love to find out what people who are putting money on the line are using as their basis to determine the future.
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PostPosted: Fri Feb 29, 2008 7:18 pm GMT    Post subject: Reply with quote

Quote:

My question to you guys is why spend the time to follow an asset class (housing futures) that is so fickle?

For most people, a house will be far and away the largest purchase of their life. It will take 30 years to pay off and have far reaching ramifications. Even the potential $20K that you suggest is substantial - that's over a third a year of income for the majority of families in the state, before taxes and interest. But we're not just talking about a $20K differential. A real peak to trough decline of 34% is closer to $200K in terms of order of magnitude. Following the futures contracts takes maybe a few hours every now and then and doesn't precluded plowing most of your time into working either. I wouldn't be making $20K more by working those extra hours, let alone $200K.

Plus it's fun.

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PostPosted: Fri Feb 29, 2008 7:42 pm GMT    Post subject: Reply with quote

Ohhhh, my God, I toootally agree; people have ragged on me for spending too much time... and I realize that there is a lot to gain and the spillover knowledge sheds light on many economic conditions which sharpens your skills on investments, market conditions, etc.

My point is that people were taking their eyes off the ball of the value of doing your homework in this as you said "far and away the largest purchase in their life".

Regarding futures contracts, however, you're not betting on your own transaction, your betting on the transactions of many people that don't have the elevated sensibility that a researched person has. You almost have to be a sociologist as well as a financial technical/fundamental analyst. What I'm saying is that regular joes that buy and sell homes and their decisions which create the statistics that you'd might be betting on are kind of wildcards to bet on wouldn't you think?

I mean think about it, say you're a judge on American Idol; you sit there and wait to see glowing talent before your eyes. That's the type of investing most do, pick winners... This sort of thing seems like the Milliondollar show with Regis Philbin where you "Ask the Audience". You're betting on the audience response/ behavior of the masses.

It's totally fun; I think the wildcard aspect makes for an awesome spectator sport BUT I'M A LITTLE FREAKED OUT ABOUT PUTTING MY MONEY ON THE LINE!!

The big wimp, John P.
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PostPosted: Sat Mar 01, 2008 3:50 pm GMT    Post subject: Reply with quote

john p wrote:
What I'm saying is that regular joes that buy and sell homes and their decisions which create the statistics that you'd might be betting on are kind of wildcards to bet on wouldn't you think?


Yes, they are certainly wildcards. If I were to buy or sell any futures contracts at this point, it would be for hedging purpose (or possibly for arbitrage). That would be tantamount to insuring yourself against the actions of those wildcards impacting you negatively. I wouldn't buy with the premise that I knew where the market was going, at least not right now. Perhaps there are some opportunities in that vein, for instance if you could model where interest rates are going and use that to put an upper bound on how wild the regular joes can be, but that's not for me at this point.

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PostPosted: Mon Mar 03, 2008 2:48 am GMT    Post subject: Historical Data Reply with quote

Love the Historical Data - you can really see the trend going slightly negative over time. It will be very interesting to see the real data overlay the bets that people are making to see how closely the index tracks reality.

I have a suggestion - at some point, their will be too much data. Maybe you restrict it to -12 months, -6 months, -2, -1, etc. That way, you can see the trend without too much data in the way.
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PostPosted: Mon Mar 03, 2008 2:47 pm GMT    Post subject: Re: Historical Data Reply with quote

SamChady wrote:

I have a suggestion - at some point, their will be too much data. Maybe you restrict it to -12 months, -6 months, -2, -1, etc. That way, you can see the trend without too much data in the way.


Thanks for the suggestion. Once the chart does get too cluttered, I'll play around with the layout a bit and see if the clarity can be improved.

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