The S&P500 fell 1.0% last week, with most of the loss occurring in the final 30 minutes of the final trading day of 2009. Volume was light and the VIX, or fear, index jumped higher. The last minute plunge was noteworthy because it seemed as though the computerized trading was simply turned off. The concern is that automated trading is now such a large percentage of the total equity market volume (60%+) that violent downside risks are extremely high, yet under appreciated.
The economic data were mixed during the holiday shortened week. The Case-Shiller index was slightly weaker than expected. Consumer confidence was also a bit lower than forecast. The Chicago PMI was stronger than expected, but the employment component was still showing contraction. Initial claims were better than expected, but the short week makes this number less meaningful. Continuing claims, when combined with extended and emergency claims, was still at record highs.
The technicals are still toppy on a daily basis. The slight rise in prices over the last four weeks occurred on some of the lightest volume of the year, giving the rise very little conviction. The weekly charts also pointing to a stalled rally that has very little gas left for strong upside movement. With a close at near the 1,100 level, the S&P500 is still conforming to the two-year downtrend that began in late 2007.
Since the asset bubble in housing was the most important factor in sparking the onset of the Great Recession, it would make sense to assess where the housing market stands, today and going forward.
As of November 2009, the Case-Shiller 20 city index logged a 29% drop from peak in housing prices in the U.S.
Where does that leave us historically? Well, prices between the late 1990’s and 2006 soared roughly 100% above the 100 year trendline, according to the Case-Shiller index. To simply revert back to the trendline means that they’d need to fall almost 50%. With a 29% decline already booked, prices would need to fall another 30%–from today’s levels–to revert to trend.
And this additional drop does NOT consider the fact that prices tend to undershoot the trend as often as they tend to overshoot the trend. If so, then prices could fall even more than 30%.
What are some of the forces that could push prices down some more?
On the supply side, banks–with the encouragement of the administration AND the cheap financing from the Fed–have been withholding enormous amounts of home inventory from flooding the market. Banks have been slow to foreclose and after foreclosing, banks have been slow to sell. This supply restriction appears to be set to reverse itself. As the Fed withdraws its easy money policies in early 2010, banks will have less ability to hold onto homes that do not generate cash flows. Supply should rise.
On the demand side, buyers have enjoyed a major stimulus. First, they have been encouraged to buy homes because of the government’s tax credit. This pushed up demand especially during the second half of 2009. The tax credit will expire, finally, in April 2010. Second, and more importantly, the Fed has shoved down mortgage rates through its quantitative easing program. This pushed up demand for most of 2009 because it provided buyers historically low mortgages, often below 5%. This Fed intervention will expire by the end of March 2010, and most economists expect 30 year mortgage rates to rise about 1 full percentage point–from 5% to 6%.
Put it all together and you get a grim outlook for housing prices–soaring supply and crumbling demand will BOTH put severe downward pressure on home prices for 2010 and beyond.
The good news? Most everyone who wants to buy a home will benefit. Homes will become more affordable. And homes will return to prices that will be more in line with long-term trends. This will make the downside risk of buying a home melt away so that buyers will be able to buy homes more confident that the prices paid will be less likely to fall further.
The bad news? Millions of more foreclosures will mean that millions of households will be going through the painful process of moving to a rental property. The banks and investors that hold the mortgages on these properties will be forced to REALIZE their losses. This means that potentially another $1 trillion of losses will need to be booked. The implication is that credit available to new borrowers will be much harder to get, and it will be more expensive. All borrowers will be affected–households, corporations and local, state and federal government.
The end result is that the U.S. economy will get dragged down in the short run, so that it can lay a stronger foundation to grow in the future. So at the very end, the bad news will ultimately lead to good news.