The Economic Roots Of Beta Climates

May 30, 2009


After finding HMI to be a leading indicator of home values, it was chosen as a gauge of the strength/weakness in the direction of 12-MF equity prices (12-MF S&P 500 Index or S&P) and 12-MF RGDP growth. If homes were in a bubble, their values should strongly influence RGDP and stock prices. My original analysis was updated through March 2009 with the 2006 period extended through December 2006.

Figure 7 observes four periods: Normalville 1984-1994; the Equity Boom 1994-1999; The Housing (HSE) Boom 1999-2006; and the Credit Bust or Bust 2006-2009. Please follow the notes in the far right column and reference the yellow highlights.

During the equity bubble, current RGDP (0.91), current S&P (0.90), household and non-profit debt growth (HseHld-NonProfit Debt, 0.91) and housing sentiment (HMI) were ONE! The 12-MF stock price was negatively correlated (-0.51) to HMI because the housing bubble was not yet strong enough to drive future stock prices.

The equity bubble collapsed in 2000-2002. A housing boom (HSE Boom) began near the S&P's trough in October 2002. A negative wealth effect caused HMI correlations to current RGDP, current S&P prices and HseHld-NonProfit Debt to be -0.26, -0.35 and -0.29, respectively. However, improving homebuilders sentiment went from being negatively correlated (-0.51) to slightly positive (0.01). The HSE Boom was having its intended effect of raising all asset prices. It was now a primary driver of stock prices.

Home values peaked in June 2006, which ushered in a period of peak risk for all credit instruments. Housing also became the primary driver of future economic growth (12-MF RGDP, 0.78). As the housing and wider credit bust unfolds (2006 through March 2009), correlations to housing sentiment became very positive for current S&P and 12-MF S&P prices (0.71 and 0.87).

Figure 8 shows the tail (HMI) wagging the dog (the S&P 500). In November 2006, we had asked: Will the 12-MF S&P decline with housing (HMI)? The HMI had fallen from 76 in 2005 to 33 in November 2006, when this question was poised. Escape from Normalville expected the S&P to follow, which it eventually did after peaking in October 2007. Housing sentiment hit its nadir at 8 at the end of 2008 and in January 2009. At its worst, stocks experienced a -43.3% 12-month decline, which answered our question affirmatively.

The recent upturn in housing sentiment will be a more reliable indicator of higher home values and stock prices if it continues to base near current levels with HMI's trough holding.


Figure 8. Housing Market Index (HMI) and $10 Growth Of S&P 500 1985-Present


After a study of Figures 7 and 8, first published in November 2006, how could Street forecasts made in December 2007 (Figure 6) be so far removed from peak risk? The Street pros got too comfortable living in Normalville. They were under tremendous pressure to go with the flow. To a degree, I sympathize with them. Wall Street's culture and their huge asset bases require them to be in for the long haul and to turn the ship slowly. If not, they face career risk.



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