Bill Gross: House Prices Heading Further Down

From PIMCO bond manager Bill Gross' latest monthly essay:

...this cycle in particular has been dominated by the accelerating trend in housing prices – making consumers feel wealthier and able to borrow/spend more money than ordinarily is the case. And so it has been a particular focus of PIMCO (and the Fed as well) to concentrate on the fate of housing in order to forecast the future of the economy, inflation, and therefore the bond market. It’s not looking that good folks – housing that is.

PIMCO’s on-the-ground analysts, who for nearly a year now have roamed the country with random real estate agents in search of local housing trend information, report that prices in many areas are actually declining which has significant implications for the economy, inflation, and interest rate trends. A just-released report by the National Association of Realtors confirms that nationwide the year-over-year housing price gains have virtually disappeared and seem to be heading into the red.

One of our centerpieces in analyzing this cycle dominated by housing is a Federal Reserve Study finished in September of 2005 entitled House Prices and Monetary Policy: A Cross-Country Study1. The 65-page treatise covers 35 years and housing cycles in 18 different countries including the U.S. While too extensive to go into detail here (and too singular to rely on entirely) I will summarize the critical two paragraphs:

We find that real house prices are pro-cyclical and tend to reach a maximum near business cycle peaks, often after a prolonged period of buoyant growth in activity has raised output above its potential level and inflation pressures have begun to emerge. Subsequently, real house prices fall for about five years and their previous run-up is largely reversed. Real GDP growth slows during the first year or so after house prices peak as do growth rates of private consumption and investment.

House price booms are typically preceded by a period of easing monetary policy with FF rates bottoming out about three years before house prices peak. Rates then reverse quickly (after the peak) in response to falling GDP growth (my emphasis).

While there have been myriads of Fed studies, many of which have proved fallible, I find many of the statistical correlations and conclusions in this one highly significant and certainly eerie in terms of the current U.S. housing boom: FF bottoming out three years (July 2003) before a housing price peak (July 2006?); buoyant GDP growth and inflationary pressures beginning to emerge (1st half 2006); and of course the critical follow-on conclusion shown in Chart III, a quick reversal of rates shortly thereafter (1st half 2007?).

On average, short rates have fallen by over 400 basis points once a peak in housing prices has been established, a necessary function of central bank policies worldwide in order to rejuvenate asset prices – housing, equity, and bond markets among them.

Comments

[Tim Smerkle]

Bill Gross consistantly forgets to mention one thing: only a country that is perceived to have a strong military to defend its economic interests is the ultimate determiner for long term, stable economic growth. One wishes Mr. Gross to have had a military experience. It certainly would have allowed him a more enlightened view on what really counts in the economic sphere.
The naive may pleasure themselves with platitudes and self-serving wordspeak about social welfare, the neo-cons (codeword for Jews), diversity, justice AND WORLD PEACE (sic), but reality will set in soon enough if the undermining of our current military policy by necessity in the middle east in particular and the world in general occurs to a point where the enemies of economic democracy assert themselves.
Mr. Gross, I believe, would be amongst the first to prostrate, paying homage to China or greater Iran if it meant squeezing a few extra dollars out of his portfolio, or to save his head in a new world order. Perhaps he would flee to Switzerland, where they are protected by mountains and no principals to defend (Jewish art and gold, Arabian blood money, mafia loot, etc.).
In short, current housing prices and some basis points on a silly bond mean little over the long term. Mr. Gross does not comprehend, nor will he ever educate himself to understand , a larger viewpoint of the big picture.
Shortcoming recognized, Gross writes a nice article every now and then.......

[Paul Meisel]

House price cyclicality seems to me to reflect consumer spending and liquidity -- so it is logical that tighter money hurts it -- but I think the housing price chart itself show the main cause, that house buyers create a bubble, which then is reflected in increasingly high ask prices, until the prices get stupid enough to start scaring buyers away.

Mr. Market exists in the housing world as well as in stocks.

[Bob Misko]

I have followed PIMCO and Bill Gross for many years. Until recently, their calls on interest rates and the bond market have been right on. They have been calling for Fed halt in FF rates for a while (3 1/2%) as I recall.
They have had a task force for about a year to follow the housing market trends as they place (like everyone else) much value in its contribution to the economy (ATM style). I reccommend Mr. Xie's recent article on golbal bond and other assets prices. Now is a good time to stay on the sidelines and wait for the prices to become more of a bargain. If Bill is right, 2011 would be a good year to buy a house!
Smiles