(Click charts to expand)
Housing prices continued to edge lower earlier this year, as revealed in the February Case-Shiller and Radar Logic housing price indices.
On an inflation-adjusted basis, housing prices have declined by 42% since their mid-2006 high, and are now back to the levels that prevailed in 2001. Sharply lower prices, combined with mortgage rates that are at all-time lows and rising personal incomes, make housing much more affordable that ever before for the average home buyer. Lower prices have allowed a huge number of homes to change hands, with new buyers absorbing the excess inventory of housing that had accumulated in the wake of the housing bust.
I've been thinking that prices were at or close to a bottom, but it looks like I was premature. Nevertheless, I think it is clear that we have seen the lion's share of the price adjustment, and that the housing market is looking a lot more stable and attractive now than at any time since 2008.
I note that the Vanguard REIT fund VNQ (above chart) has rebounded significantly from its 2009 lows, and today is only inches from its post-recession high. VNQ has generated a total return of 238% since the March '09 low, compared with the S&P 500's (SPY) return of 117%. Avoiding the real estate market has not proved to be a profitable decision, despite the ongoing decline in prices. What this tells me is that in late 2008 and early 2009, the market way over-estimated the degree to which the housing market would eventually collapse. We haven't seen home prices rebound yet, but since prices today are much higher than the market thought they would be, this has been the equivalent of good news for investors.
And so it goes for the economy. I've been bullish on the market because I have believed that the market was priced to an extremely pessimistic view of the future. I haven't been bullish because I thought the economy would be growing by leaps and bounds; I've been bullish because I thought the economy would grow by more than the market expected, and that proved to be a pretty low hurdle. Since the future has not turned out to be as bad as everyone thought it would be, valuations have improved. And since 10-year Treasury yields are still at a miserably low level (2%), I think the market is still priced to an awfully weak economy (e.g., another recession) going forward. So you don't have to be very bullish on the economy to be bullish on equities. If the U.S. simply avoids a recession and continues plodding along at a very modest rate, that could be good enough to drive further gains in equity prices, and eventually some significant declines in Treasury note and bond prices.
Another way to look at this: lower home prices are not necessarily bad news. What's important is whether markets continue to clear, and whether the economy's scarce resources are being put to more productive use with the passage of time. So far, this looks to be the case.