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As the Federal Reserve's (Fed) tight interest rate policy regime continues to put upward pressure on mortgage rates and recessionary trends (and other notable economic headwinds) to the macroeconomy steadily worsen, it is becoming fairly clear that the U.S. housing market is headed for a severe downturn.
The most important questions for the housing market right now are when will home prices peak this quarter and what will be the pace and magnitude of the decline?
I have developed a model to answer these questions using historical trends as a general guide, as well as a generous amount of pure speculation based on my direct experience with the last two housing market downturns.
First, while my outlook may seem very pessimistic to many, I held a similarly pessimistic outlook for the housing market back in 2006. And looking back at my posts from the years before the Great Recession, I think my views at the time were actually spot on, or maybe a little too optimistic, for the times we were heading into at the time.
In general, my core principle regarding the dynamics of highly speculative and delusional markets and asset classes is simply stated as “what goes up must come down” as the bubble inflates, and then as the delusion collapses, the sentiment changes to “the bigger it goes, the bigger it must fall.”
In other words, speculative trends tend to rise first and then fall, and over the long term, their primary function is ultimately mean reversion. In some cases, the “average” may be zero bound, but for fundamental asset classes such as housing, over the long term, the trend will be a slow, steady (and far from exciting) upward random walk that keeps up with inflation, but no more, no less.
At the moment, we are at the crossroads of numerous Fed-induced “easy money” speculative delusions during the “everything bubble” era. Stocks, homes, and alternative investments (crypto, NFTs, SPACs, etc.) have all (until recently) been soaring at least the past 2 years, with stocks and homes running at full speed, propped up by zero interest rates and quantitative easing policies for the past 13+ years.
Given that much of the general economic activity that has surrounded us since 2008/09 is little more than a fiction created by the Federal Reserve, and we will never truly know what the fundamental trends would have been in the absence of market manipulation, it is very difficult to compare current periods in the housing market (or any other asset class) to previous periods.
But in any case, I have used a simple quantitative approach that reflects the “key principles” to model the trends, linking the size of the boom with the scope of the bust, and linking the current cycle to the previous two cycles.
Let's start by looking at Robert Shiller's long-running nominal home price index (blue left axis) and its month-by-month year-over-year percentage change (red right axis) since 1953. Note that the index is composited from multiple source indexes, as the S&P CoreLogic Case-Shiller only goes back to the 1980s.
It is interesting to note that the scope and size of each housing bubble since the 1980s has grown as the cycle progressed. Below is a table outlining the details of the 1980s, 2000s, and current 2022 cycles.
Notice that the year-over-year (YOY) percent change for each cycle has increased by a factor of about 1.5 for each subsequent cycle. While I don't believe this is some magical factor, I take this as a general indicator that the current upswing has nearly reached its maximum uptrend, as well as the magnitude of the minimum YOY when the downturn will eventually begin.
Now look at the following graph showing the S&P CoreLogic Case-Shiller Home Price Index during the “Savings and Loan Crisis” boom and bust cycle of the late 1980s (a subset, not the entire cycle): Notice how it highlights both the strongest monthly year-over-year percentage change (February 1987, light red bar) and the strongest monthly month-over-month percentage change (June 1987, light green bar), as well as the weakest of both (April 1991 had the largest negative year-over-year percentage change, November 1990 for MTM).
Remember, while the savings and loan crisis was a major event, its boom and bust affected real estate markets primarily in major cities and their associated suburban areas on the East and West Coasts, and was not widespread across the United States like the “Great Housing Bubble” cycle that eventually occurred a decade later.
My graph shows the “national” S&P CoreLogic Case-Shiller Home Price Index, and this cycle looks muted compared to recent cycles because the spikes and falls in home prices have been primarily regional.
Now take a look at the chart below showing the S&P CoreLogic Case-Shiller Home Price Index for the “Great Housing Bubble” boom/bust cycle (a subset, not the entire cycle), and note again that I have highlighted both the strongest monthly YOY and MTM gains/losses and the weakest monthly gains/losses.
Clearly, the “housing bubble” lasted much longer than past cycles, reached much higher levels, and ultimately crashed much more violently. Amazingly, it took approximately 174 months to peak and another 67 months to bottom out, after which the peak gain was a whopping 143%, before plummeting 27% during the crash before ultimately declining to a net gain of 77%.
Finally, check out the chart below, which shows the “everything is a bubble” boom and bust cycles (a subset, not the entire cycle) for the S&P CoreLogic Case-Shiller Home Price Index, along with projected price trends through 2030 (all data in the yellow band).
My prediction for future price movements is very simple and includes the following key assumptions:
1. The March 2022 month-on-month (MTM) percentage change of 2.58% will be the largest monthly increase seen in this cycle given that the S&P CoreLogic Case-Shiller is a three-month moving average and will now begin to capture price movements reflecting higher mortgage rates, which began to rise in earnest in March.
2. The year-over-year (YOY) percentage change is approaching a maximum, and my projection is that it will reach 21-23%, roughly 1.5 times the maximum YOY percentage change seen in the last cycle (14.5%), at which point all subsequent monthly YOY numbers will continue to decline and eventually enter a deeper decline later this year.
3. The overall downward trend in prices will play out similarly to the “great housing bubble” cycle, except that the monthly declines will be somewhat steeper due to the sudden surge in price appreciation and the sudden reversal in mortgage rates.
We will continue to update this forecast and revise our overall theory and key assumptions as new S&P CoreLogic Case-Shiller data settles in, but currently, we believe the strongest monthly MTM changes were seen in March, with the largest annual year-over-year changes approaching in November of this year, and a peak in prices likely sometime next year based on the impact of rising mortgage rates on market activity.