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August 1, 2006
Timing The Market & Monetary Policy
A: Timing the housing market is extremely difficult but not impossible. You have to understand that like in poker, you'll never time it prefectly. In no-limit texas hold'em (a poker game that is just way too much fun), I put my bets on my skill of play and observations at the table rather than in luck. I strongly believe that I can outsmart my opponents either before the flop or post flop regardless of the cards I'm holding. With respect to timing the real estate market, its kind of similar. You'll never be perfect and like in no-limit hold'em, you will get beat sometimes by NOT timing the market perfectly. Thats just the way it is. However, by using some savvy observations as to where monetary policy is headed down the road you can get close to timing the market. Here is why!
Monetary policy is set by the FOMC and fed chief Ben Bernanke to control price stability and fend off inflation. The goal is to keep the economy growing, fend off inflation, and price stability in our currency. Sometimes it all doesn't work out that way as the real world does what it wants. But I do know this: AS RATES RISE AFFORDABILITY GOES DOWN AND BUYERS CAN BUY LESS HOME IN TERMS OF DOLLARS. AS RATES EASE AFFORDABILITY GOES UP AND BUYERS CAN BUY MORE HOME IN TERMS OF DOLLARS. THIS CORELLATION BETWEEN MOVEMENT OF INTEREST RATES AND AFFORDABILITY HAS BEEN PRETTY CONSTANT IN PAST HISTORY.
By sticking to this mantra and following the fed's direction with interest rates (an understanding of global geo-political conditions, inflation pressures, and US economic data will help in deciphoring the fed's statement and their most likely course of action at future meetings) we can get fairly close to timing the housing market; BUT NOT PERFECT!!! You must understand those last 3 words! You will NEVER time the market perfectly!
Now, lets look at a chart of the last 5 years or so of both monetary policy and the growth in the housing market. First monetary policy since early 2000:
Now, lets look at a chart of the US housing market since early 2000 and see if we can deduce any information (this was only chart I could find so it will have to do):
Hmmm. So, monetary policy bottomed out mid-2003 after undergoing a massive 600 basis points rate easing cycle (thats 6% to all you home gamers). Notice how the housing price chart didn't really show a huge jump in gains from 2000-2003 (jump from 165K to about 190K). The real jump occurred between mid 2003 and late 2005, a good two and a half years AFTER monetary policy bottomed out. Therefore we can deduce that home buyers between late 2001 and early 2003 timed the market perfectly (that is if they chose to sell recently or are in the process of selling).
Note that this time period of late 2001 to early 2003 represents the NEARING OF THE END OF THE RATE EASING CYCLE & THE BOTTOMING OUT OF THE FED FUNDS RATE. Since monetary policy is lagging in its effects, it is fairly safe to say that a GOOD TIME TO BUY IS WHEN THE FED IS NEARING AN END TO A RATE EASING CYCLE, as the results of the after-effects are shown in the above house price chart.
On the flip side, note that the dropoff in house prices since early 2006 represents THE NEARING OF THE END OF A RATE TIGHTENING CYCLE. We are still waiting for the results of what happens AFTER the fed finishes their rate tightening cycle. However, we can safely say that a GOOD TIME TO SELL IS WHEN THE FED IS NEARING AN END TO A RATE TIGHTENING CYCLE.
Look here for a visual representation of what I just said:
Make sense? Read it all again if your a bit confused. The effects of monetary policy are lagging so when the fed cuts rates to stimulate the economy by making money less expensive to borrow, the real world doesn't see the effects for a good year or so. As in recent past history and dictated by the charts above, it was from early 2003 to late 2005 that the housing market saw incredible gains, about 2 years AFTER the fed starting cutting rates and 2 years AFTER rates bottomed out! Not an exact sciene or a crystal ball, but certainly a good guide!
Posted by urbandigs at August 1, 2006 3:43 PM
A couple of thoughts:
After yesterday's inflation report, I don't see how Bernanke cannot raise rates by 25bps. But, I doubt he will. I'm betting he will pause and possibly cut rates by year end (for political reasons). Maybe good for the markets as it reflect a superficial (weak) defense of asset value against recession, but very bad for the dollar.
In contrast, Treasury Sec. Paulson spoke at Columbia yesterday and affirmed his commitment to a strong dollar policy. This would imply defending the dollar against inflation to prevent further currency erosion.
How do we reconcile the above contradictions. We can't have it both ways - a strong dollar and no recession; high asset value and no inflation. So right now we are stuck with stagflation, correct?
Regarding RE, the tide has turned, the market pyschology is different, we are on the early downslope of a bubble that has peaked. So, regardless of what Bernanke does with interest rates, the downward trend will continue.
What will affect the market more than a pause in rate hikes is the tighter lending standards that will come into effect on September 1, 2006. Additionally, Fannie Mae and Freddie Mac now have a portfolio cap on investments in mortgages and MBS. This will also cool the lending of riskier mortgages to marginal homebuyers. Both of these actions will limit the potential pool of buyers available. And, let's not forget the ARM resets that will occur over the next 18 months or so.
In terms of our local market of NYC, I don't expect a good buying opportunity until 2008. For me, its the summer '08 - spring '09.
And I firmly believe, we won't get to the bottom until properties start selling at a more normal rate of ~$500-600 sq ft below 96th street; and ~$250sq ft above 96th street.
Posted by: jmr at August 2, 2006 7:26 PM
JMR,
Insightful anaylsis. Yes I think you are correct.
On Interest Rates: I dont see how Bernanke & Co. can NOT raise another 25 bps next week, however I would expect a dovish statement. That core inflation # was just way too scary! If he expects a cooling economy to offset inflation pressures, then I think that is expecting alot! One thing is for sure, Greenspan wouldn't mess around and if he was still at the helm, 6% fed funda rate would probably be the target.
On RE: Agreed 100%. Psychology has changed and buyers are just not chasing. And what you said on lending regulation will definately constrict the buyer pool.
On NYC & PPSF thoughts: I think you'll see some deals in that target range but not all. Average ppsf for condos is still probably close to $900/sft. If that sinks to $700/sft, the market has experienced quite a correction. But you could be right. I certainly agree with your timeline and I will look to buy again in 2008-2009 or so.
Posted by: Noah at August 3, 2006 2:02 AM
I agree, your comments are right on.
Posted by: Larry at August 3, 2006 6:41 PM
if prices drop to 500/sft, that would be a bubble burst of over 50%. i do not think that would be a positive sign. in the past market corrections, the most they adjusts have been is a max of 15 - 20.
Posted by: bob at August 24, 2006 9:15 PM
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