Laura Kusisto challenged home price bears in a thoughtful WSJ piece a few days ago called Housing Market Positioned for a Gentler Slowdown Than in 2007.
Let me offer my two cents (and agree, for the moment) by showing how different Case Shiller home price futures look today versus the 2006-08 period.
The graphs below show:
- A graph of closes for the Nov 2006, Nov 2007 and Nov 2008 CUS (10-city index) futures from May 2006 to Nov. 2008. There is also a black line for the Case Shiller 10-city index. (This was prepared for my one academic paper on this subject. Copies available upon request.) Note that the Nov 2006 contract was just below the Case Shiller index for the six months before expiration -even as the Case Shiller NSA index continued to rise. The Nov 2007 contract closed below the Case Shiller index for an entire year. (In those days, only one-year contracts were available so we only have a year of this contract vs. index comparison.) Finally, the Nov 2008 contract closed at deep discounts to then current index values throughout 2008. It seems plausible that traders of the contracts (which recall would settle on a forward value) may have been channeling expectations of a declining Case Shiller index (which recall looks backwards to a 3-month moving average) into lower clearing levels (among other reasons for buying/selling).
- By contrast, as shown in the lower graph, contract closes for the Nov ’18, ’19 and ’20 contracts have been above index levels (again shown in black) as traders may believe index values will be higher by expiration (again with the same qualifier that traders have lots of reasons to buy/sell beyond long-term expectations). Further, and importantly until very recently, contract prices have been rising, consistent with the possibility that traders were getting more bullish on forward expectations throughout late 2017/early 2018, as monthly Case Shiller releases surprised on the upside (a topic that I’ve written about in recent blogs in May and June 2018 .
Given today’s graphs, it seems overly bearish, or premature, to equate today’s home price markets with 2007-08. There may be bigger troubles ahead (similar to how some home price forecasters in 2005 were later proved correct) but at this point, such sentiment doesn’t seem to be showing in CME prices, or (to Laura’s point), this cycle may not be as severe as 2007-09.
Two important caveats:
- I’d begin to worry more if futures prices continued their recent compression down to spot levels, and particularly if they began to trade at a discount. I’ve touted in past blogs how longer-dated contracts (which, again didn’t exist in 2007) tend to have magnified reactions. Best to keep an eye on calendar spread quotes, or premiums of longer-dated contracts to spot for signs of distress. As shown from the 2006 period, were Case Shiller index levels to eventually turn down, it will likely show in futures trading at a discount to spot first as traders sell forward contracts.
- The volume in today’s CME contracts is <10% that of 2007. That means that markets are not deep and that price levels might change on small order imbalances. While hedging home price risk over the last few years of a rising home price market did not likely add to profits, I am getting a growing number of inquiries for people more interested in hedging. With over 100% gains from the bottom in 2012 on some markets (e.g. SFR index was 124.64 in 2012, and is now 268.34), I might expect hedgers to not worry about capturing the last point. This combination of thin markets and a possible built-up desire to hedge large gains may contribute to contract volatility should fundamental home price news worsen.
Feel free to contact me (johnhdolan@homepricefutures.com) if you’d like to discuss this blog or any aspect of hedging home price indices.
Thanks,
John