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How Home Prices Can Affect the Stock Market

Wooden houses stand in a row from small to large with a red arrow up. concept of high demand for real estate. increase energy efficiency of housing. rise in house prices. property. population growth; Shutterstock ID 1220932237; Project: LBE

Larry’s note: Welcome to Trading with Larry Benedict, my free daily eletter, designed and written to help you make sense of today’s markets. I’m glad you can join us.

My name is Larry Benedict. I’ve been trading the markets for over 30 years. I got my start in 1984, working in the Chicago Board Options Exchange. From there, I moved on to manage my own $800 million hedge fund, where I had 20 profitable years in a row. And, I’m featured in the book Market Wizards, alongside investors like Paul Tudor Jones.

But these days, rather than just trading for billionaires, I spend a large part of my time helping regular investors make money from the markets. My goal with these essays is to give you insight on the most interesting areas of the market for traders right now. Let’s get right into it…

Today I want to show you why home prices are important, and their effect on stocks. 

Apart from the direct benefit to the homeowner, home prices have a multiplier effect across the economy. When prices are rising, homeowners are more inclined to travel, shop, renovate, or dine out.

But, if that growth should slow or even inverse, then they are more inclined to close their wallets.

When the Fed started cutting interest rates around two years ago, one of the biggest beneficiaries was the stock market.

From the March 2020 low to the late-2021 high, the market saw a truly stellar run. During that time, both the Nasdaq and S&P 500 indices more than doubled.

However, stocks weren’t the only asset class to rally strongly…

Property, in particular residential homes, also went on a tear… especially last year.

For example, the annual growth rate sat around 12% in February 2021… by July it had risen to 20%. You can see just how steep that rise was in the table below.

The U.S. Case Shiller Home Price Index YoY (year over year) shows the annual percentage growth of home prices…

United States Case Shiller Home Price Index YoY

Source: tradingeconomics.com

After peaking in July, that number drifted slightly lower until December.

While lower interest rates helped push prices higher, there were several other factors at play…

The pandemic caused many folks to re-evaluate where they wanted to live (given remote working).

Plus, a shortage of materials and skilled workers for new home construction (and the associated delays) saw buyers chasing an already short supply of existing housing.

That helped push prices even higher…

While regular top performers like Phoenix and Tampa posted annual growth rates of around 30%, price growth has been strong right across the board…

The latest data for January saw annual growth ticking higher to 19.1%. All 20 cities used in the Case Shiller Home Price Index saw home prices go up, with 16 growing at a higher rate than December.

For now, that helps paint the picture of a growing and healthy economy.

However, there are a couple of things we need to remember.

First, last month’s rate rise has yet to flow into the home growth data. With the time lag of the data, it will take another couple of months to start coming through.

And second, it looks very likely that a potential 0.5% raise is coming at the Fed’s next meeting. Plus, more potential rate rises after that.

That’s why I’ll be watching this sector more closely throughout 2022.

With the Feds turning off the cheap money tap, it’s going to become increasingly difficult for home prices to keep growing anywhere near the current rate.

It simply isn’t sustainable long-term…

The eventual slowdown in home price growth will have a negative impact on the multiplier effect on the economy and the stock market as a whole.

As I wrote last week, investors have been enjoying a nice little relief rally over these past few weeks. After a rough start to the year, the market was due for a bounce.

However, the game has changed. The Fed acted way too late when it came to raising rates.

Right now, the Fed is miles behind the inflation curve…

While we’ll still have some periods where house prices (and stocks) increase in value, ultimately the pure weight of sustained interest rate rises over several years will bring any stock rally and this unsustainable home price growth to an end.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

Reader Mailbag

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