The housing market is a market known for its uniqueness and specificity. The issuance of mortgage backed securities, eventually leading to the 2008 crisis, was an attempt to spread this unique risk through the bundling of mortgages into investment packages. The crisis and its economic and legal consequences have led to a current foreclosure backlog which is likely to drive inventory in the housing market for a while. In this context, it is interesting to note that a company, Radarlogic, has derived a daily and national housing indicator in a market known for its regional and slow-moving nature. A relatively fungible daily housing index would provide the necessary level of liquidity to drive futures quotations on the index (so far housing indicators like the Case-Shiller index have been monthly or even less frequent) . And, indeed, a futures on the RPX index has been quoted since February 2012.
RPX Index based on Triple Power Laws marries apples and oranges
In order to translate housing data, infrequently quoted, with stale data which is nevertheless significant, Radarlogic has created a methodology to track and use the old data, while nevertheless updating daily information that comes in, by using Triple Power Laws. Without getting into the nifty details of this approach, detailed in a white paper published by the company and available on the website, the basic idea is to accurately measure the price per square foot in a region (or nation). This allows for greater homogeneity of price quotation, and the price per square foot so calculated is determined by a probability distribution function which separates the "shape" from the "position". The shape is determined by the "quality" of the housing market, and changes slowly. The position is supposed to be determined by the relation between quality and value in a market on a given day. These variables are then married together by means of a power law which takes into account price difference in the high, medium and low end of the power spectrum. The RPX index can then take into account all data which is relevant to determine price per square footage, such as length of time the house is on the market, quality of neighborhood, condo sales in the area, even if this data is stale and spit out a daily index, determined by both the shape and position.
One is contango the other not.
One of the ways that one can determine whether the index is a good daily indicator of the price per square footage is to look at how the futures prices have behaved for contracts quoted to date.
The following two graphs show quite different behavior of the RPX futures (RPXCP) for March and September 2012 expiration. The futures for March 2012 expiration exhibited contango behavior, the September 2012 futures exhibited backwardation. (One assumes the reference value at expiration published by Radarlogic to indicate expected spot price).
The reasons why a futures market would be in contango or backwardation are complicated, but one reason why the RPX futures would initially be in contango (March 2012 contract) and then backwardation (September 2012 contract) might just be because the housing market turned quite dramatically towards the middle of September 2012, as the year to year price changes in the monthly Case-Shiller HPI index shows below.
In other words, the RPX futures were in contango for March 2012 because of the initial glut in the housing market, which turned into a more bullish situation mid 2012. Indeed, in the first quarter of 2012, the National Association of Realtors indicated that the median single-family home price rose in 74 of the 146 major metropolitan areas. In addition, home inventory was also shrinking, with 22% fewer homes for sale in the first quarter of 2012 compared to the prior period, leading to an upward pressure on price. If the RPX index, and a fortiori the futures on that index captured these trends, that would explain the reversal to backwardation from contango.
What about 2014?
The RPX futures is beginning to gain traction, with open interest increasing steadily over the year for the February March 2014 contract.
The market, initially quite pessimistic on the median price per square foot in June of this year is now stabilizing at a view of approximately $200 per square foot nationally, according to the above graph. Open interest has also been increasing over the year for the March 2014 contract. Most probably what is factored into the futures price are many indicators, including macro trends, and more importantly the foreclosure backlog. Realtytrac indicates that foreclosure activity has declined somewhat from last year, with a U.S. average of 1 in every 998 units. Nevertheless, even if current activity shows a moderate decline, the foreclosure backlog remains a threat to any recovery, and the RPX futures seems to be taking that into account into 2014, with no overt optimism regarding the housing market, but no manifest pessimism either-just stability.