Freddy Hutter, ...'s  Instablog

Since May 2008, the original version of this scenario has been predicting the return of the USA Existing Home Median Price to its 2-earner Family Income ratio trend.  Final figures for 2009 confirm that our target of $174,000 was overshot by a mere $1,988!  Our 2009 New Home Price target of $219,000 was overshot by only $3,605!

The correction plunge was unexpectedly swift ... much faster than originally forecast, and resulted in a return to the trend line in January 2009.  It is no accident that the Severe Recession came to an abrupt end in April ... prior to delivery of the first fiscal policy stimulus cheques.  Nasty real estate & mortgage practices caused the economic contraction, and the return to norms also got it out of the downturn by restoring Confidence.

Prices peaked for both New Homes & Existing Homes in 2007Q1, and the completed correction exhibits a classic "return to the mean".  The irrational exuberance commenced in 2002 and culminated in a break from the Existing Home Price norm (2.0) to 2.8 x's 2-earner Family Income.  Similarly, New Home Price drifted from its long term metric (2.5) to an unsustainable 3.1 x's Income.

The Existing Home Price monthly median dropped 28%, from $229,000 (June 2007) to $164,700 in January 2009.  This is far less than the silly 40% prediction (2008/11/18) by McDoomer Nouriel Roubini.  But then, he also forecast (Nov/2008) that 1,400 banks would "go bust in 2009".  He was out by 1,250 on that call.  But i digress!  After the low point of monthly sales in January 2009, they rebounded 43% by November.

The median monthly New Home Price decreased 22%, falling from $262,600 (March 2007) to $205,100 in March 2009.  Unit sales rose 27% from the January low by July.

The Existing Home Price had been up $17,100 from the low, but returned to exactly that price bottom of $164,700 again last month ... which is almost $16k shy of our 2010 target of $180k.   By May, the New Home Price had recovered $17,200 from the bottom in March, but in January set plunged to a new recent low of $203,500 ... and is a $24k overshoot of our $227k 2010 target at this time.

As seen in the chart, it is probable that new highs for New Home Price will not be set 'til 2013.  Existing Home Price records should be stalled 'til 2016.

When yesterday's Existing Homes report is compared to Canada's MLS data, it's quickly seen that a very different scenario is unfolding North of the 49th.  Due to winterization, Canadians spend an average 2.7 x's 2-earner Family Income for their residences, compared to a 2.0 factor in the USA,  Add to that a slightly higher Income level in Canada, and Canadian Home Price has averaged 35% greater than American over the last four decades.  The gap before 2005 is somewhat meaningless as currency exchange rationalization would cause the difference to virtually evaporate.

Analysis reveals that Home Price in both nations detaches from the price/income ratio trend in 2002.  Lower interest rates made upgrade purchases almost painless.  Then irrational exuberance set in.  But while the USA Price started to correct in 2007, the Canadian Price had a faux pause in 2008 and has just set a new high in January 2010 of $329,000 .... double the January American Price of $164,700.

By trend measure, a Canadian Home Price of only $261,000 is indicated for this year.  The average Price of a residence in Canada is in a $68,000 realty bubble.

Fortunately, Canada is enjoying an economic recovery that is much more robust than their southern neighbour.  In this environment, there is little prospect for a precipitous collapse.  For unlike the USA, Canadian home prices are not in uncharted territory.  The price/income ratio skyrocketed to 4.0 back in 1990, and Canada faced a $48,000 housing bubble.

By 2001Q1, the country was in the depth of Recession, and Avg Price commenced a gentle 5% overall decline that transpired over a period of six years.  Based on that episode, it is quite probable Canada will grow out of its present $68,000 housing bubble with a similar sideways correction stretching out to 2014 ... not the 28% 24-month event witnessed in the USA.  Assuming Price peaks this year, the high will not likely be breached 'til 2016.

USA Houseing Bubble - New Homes vs Existing Homes:
 
BACKGROUNDER:

Back in May 2008, we were concerned that some pundits disavowed the USA housing market was in a bubble, whilst others (like Nouriel Roubini) predicted a massive collapse.  Based on a long time commitment to Price/Income ratios, our first effort determined that Existing Homes were inflated by $60,000 at the height and would take nine years to correct.  To our amazement, the classic "return to the mean" did not mirror the early 90's Canadian Housing Bubble and the correction was complete by January 2009.

In order for the realty sector (and general economy) to recover completely, we had been awaiting four bottoms.  The first two were Existing Home transactions/month & Existing Home Median Prices.  Done - January & January (2009) respectively.  The remaining pair was New Home monthly sales & Prices.  Done - January & March (2009) respectively.  An increase in monthly transactions was important to the Economy 'cuz it brings on increased revenues in furnishings, landscaping/gardening, appliances, etc.  And for New Homes, rising sales mean "jobs".  The passing of the bottom of Prices for both categories is important 'cuz the subsequent apparent increasing "wealth effect" affects consumer demand and durable good sales.

A return to the mean is both natural and necessary for economic stability.  In the early 80's & 90's, we saw the Fed raise rates to embattle Inflation psyche.  The upward effect on mortgage rates left less Disposable Income for consumers to spend on holidays, clothing, durable goods, etc ... and Recessions ensued.  The purpose was to quell overheating Economies.  And it worked.

In 2001, the Fed lowered interest rates to draw the Economy out of its Technical Recession.  The consumer, recently burned by the Dotcom fiasco, began to invest heavily in Real Estate rather than the volatile, collapsing Stock Market.  Low interest rates enabled the purchase of more expensive homes for the same monthly servicing cost, even w/o an increase in Family Income ... and housing inflated.  At the same time, new sub-prime mortgages flourished; and was compounded by rampant fraud by buyers, mtg brokers, appraisers, lawyers, lenders, and mtg aggregators.  Apparent Demand was greater than Supply and the Realty Bubble was under way.  As Existing Home Prices attained levels of 2.8 x's Median Family Income, it was clear that irrational exuberance was fuelling the frenzy.

The USA norm for Median Existing Home Prices is only 2.0 x's Working Couples Median Income.  With extraordinarily higher prices, many families were drawing from their Disposable Income to pay for higher monthly mortgage payments.  This left less funds for family budget spending on holidays, clothing, durable goods, vehicles, etc.  Add to the fray the higher energy costs for transportation and heating fuel and we had the recipe for a Severe Recession.  The Fed recognized this scenario unfolding and attempted a succession of lower Interest Rates to keep the Economy humming ... but alas, could not avert negative GDP growth rates.

Disclosure: (no stocks mentioned)