U.S. Housing Futures Look Bleak

Most of the reporting on U.S. housing prices has been through the rear view mirror. Let’s take a forward look through the eyes of futures speculators at the Chicago Mercantile Exchange (CME) with the Composite U.S. Housing Index.

We don’t know the profile of people speculating on housing futures, but we’d bet it’s not the same profile as the typical buyers and sellers of the homes that are the subject of the index. We also don’t know the predictive value of the index. It hasn’t been around long enough as a futures product to be evaluated in that way. Nonetheless, it is interesting to see what the futures market thinks.

Here is a chart of the Monday Oct. 29 closing price for the U.S. Composite Housing Price Index for all open futures contract months through November 2011. It’s not a pretty picture.

If the futures speculators are correct, we are in for a period of about 3 years of continuing declines in aggregate housing prices.

Translated into a percentage chart, futures predict an approximate 12% drop over the next three years before flattening out.

We all know that real estate is a local asset with great differences between and within communities. Some communities are still rising rapidly and some are sinking rapidly. However, if the futures speculators are correct, the implications are significant, although not necessarily easy to pin down. All that is relatively certain is that a further 12% drop in aggregate home prices would cause a lot of other dimensions of the financial world to change too.

What might change?

Lower home prices would probably mean fewer houses being put up for sale voluntarily, which would tend to reduce turnover, which in turn would reduce demand for mortgages, which would tend to lower mortgage rates.

At the low end, housing affordability would increase due to the combination of lower prices and lower mortgage rates.

Greater housing affordability may reduce the profitability of rental housing on the margin, perhaps impacting apartment REITS such as Equity Residential (EQR).

Another knock-on effect possibility would be that the large crop of baby-boomers who have begun to retire might stay on the job for a few more years to weather the real estate storm. The concerns and fears that would represent, might show up as more conservative securities investing — perhaps more allocation to bonds (AGG) and less to stocks; or more to large-cap U.S. stocks (SPY) versus small-cap (IWM) or foreign stocks (EFA) and (EEM).

Nobody really knows how things like this will play out. There are always surprising twists and turns. The past is no perfect indicator. As one writer pointed out last week, Warren Buffet said something to the effect that if the past could be used to predict the future, the richest people would be librarians.

So, with an awareness of the past, a sense of the present and your own crystal ball about the future, it could be useful to think through whether you believe house prices will fall for the next three years and how that will impact other investment markets.