Posted: November 7, 2022

The housing market is cooling, but the downturn may be overhyped. That is both a blessing and a curse.

Data released this past week showed that U.S. home prices fell in August at the steepest month-over-month pace in more than a decade, with the S&P CoreLogic Case-Shiller National Home Price Index and the Federal Housing Finance Agency index declining 1.1% and 0.7%, respectively.

Taylor Mann, an economist at real estate brokerage Redfin , offers more recent stats: Fewer homes are pending sales than in any October since at least 2015; touring activity is down 27% from the start of the year, compared with a 7% increase at the same time last year; and the Redfin Demand Index declined 11% in the past four weeks to its lowest point since May 2020.

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None of that is surprising given the sharp rise in mortgage rates since the Federal Reserve began tightening monetary policy. The average U.S. 30-year mortgage rate hit 7.08% on Thursday, the highest level in about 20 years. Eric Finnigan of John Burns Real Estate Consulting says the move in mortgage rates this year has boxed out 24 million households from a $400,000 mortgage, meaning that the pool of potential buyers has shrunk by 47% since December.

Even so, the situation isn’t as dire as headlines suggest. “I keep reading how the housing market is just so overvalued and a crash is coming,” says Michael Ashton, an investment manager at Enduring Investments. “I’m not holding my breath.”

There are three reasons to remain skeptical of a housing-market bust. Ashton explains one of them. Housing is a real asset, and if it is going to crash, we will need to see a crash in the level of M2—a measure of the monetary supply that includes currency, deposits, and shares in retail money-market mutual funds, he says.

Massive MoneyThe level of M2 money supply is still close to a record high.Source: Federal Reserve Bank of St. Louis

M2’s rate of growth has slowed markedly, rising 1.7% year over year in early October compared with a 13% rise a year earlier. But it is the level, not the rate, of M2 that matters, says Ashton. The level of M2 in September was up 2.6% from a year earlier and is little changed from its spring peak.

As Ashton puts it, the price of something is affected by two factors: its value and scarcity, and the value and scarcity of the dollar. It is akin to the “diamond-water paradox,” where diamonds are worth more than water not because they are more useful than water but because there is much more water than diamonds. If you have the same quantity of a real asset, like houses, and many more dollars, then home prices rise because those dollars are worth less and a house commands more dollars, he says.

The relationship is close to linear, with M2 and the Case-Shiller home price index both rising 43% over the past three years, notes Charlie Bilello, CEO of Compound Capital Advisors.

Monetarist theory says money supply times velocity—or the rate at which money is spent—equals price times quantity. Hewing to that, Ashton says the 20% drop in home prices over the next year that some analysts are predicting would require a 20% decline in money supply, all else equal. That, he says, is quite unlikely.

Supply is a second reason housing may prove relatively resilient. Eric Basmajian, founder of EPB Research, says there is a tight correlation between the total supply of U.S. housing and home-price growth six months out. The current supply of homes would take four months to sell and suggests that home-price growth will be roughly 7% six months from now, he says.

Original Artical : https://www.barrons.com/articles/home-prices-crash-housing-market-51666988277