Which Indicator Has Picked 5 Of The Last 8 Major Real Estate Market Bottoms Since 1990? …and Why Does This Discovery Mean We're Looking At 10-15 Percent Growth In House Prices Before This Financial Year Is Out.
Call me mad… call me genius… call me what ever you like…but as you know I always prove my opinions and views with factual evidence… not B.S or fluff.
This article is a bit of a tech-y one, but I know a lot of my readers like to keep up with the technical research, and are a lot brainier than I am, so I'll try step us through it.
But if a bunch of graphs is the kind of picture book that sends you to sleep, the upshot is this: the recent run of interest rate cuts are telling us to look house price growth of up to 15 percent before the coming year is out.
We all know how important interest rates are for the housing market. When interest rates fall, people can afford to pay more for houses – they can service bigger principals – and so they bid up the price of the existing housing stock.
That's not why Glenn ‘Golden Boy' Stevens messes with the interest rate lever, but that's what happens. Almost like clockwork.
Of course it's not the only factor affecting house prices, but the conventional wisdom is that it is the most dominant one.
But how important is it? And how much impact do we think the recent run of rate cuts – 200 basis points and counting – is going to have on prices?
That's what I wanted to find out. So let's have a look.
Let's start with a chart of house prices. If you've been reading these blogs it should look familiar to you. Check out some of the older blogs if you want to know exactly how it's put together.
We'll kick off at 1995 – more or less the start of the current monetary policy era.
Then, let's lay interest rates over the top of that.
The series seem to be moving together, but it's not obvious what the relationship is. So let's tease it out.
The first thing to do is flip interest rates on it's head. Why? Because there is an inverse relationship between rates and prices. As rates go down, prices go up. So if we flip interest rates upside down, we can see it a little more clearly.
From there, the power of the relationship is starting to emerge. We can really see how shifts in the stance of monetary policy affect house price growth.
The red circles on the graph above highlight our turning points. And we can see that before almost every acceleration in house prices over the past 20 years, there's been a run of rate cuts.
So obvious, yet people still fight me on this trend… Crazy!
Let's move on…
Again, no real surprises there. This is what the theory tells us we should expect to see, and it's the conventional wisdom – that rate cuts leads to price spikes.
And the most recent string of rate cuts is having an impact on prices, but how much impact will they have? That's the really interesting question.
To get an answer to that, I had to do a couple of things. The first is I wanted to get rid of the downward trend in interest rates. Since the mid 90s, interest rates have been ratcheting lower and lower – as inflation got beaten out of the system, and interest rates across the world also moved lower.
So I wanted to try cut through this, and just look at the total change interest rates, and not get too caught up on the actual level (this also makes a bit more sense – since we're looking at the growth in prices, we should be comparing it to the ‘growth' in interest rates).
Get's a bit heavy here, but it keeping up with me the results are worth it.
So what I did is built a series that looks at the cumulative change in interest rates. So for example, the first rate cut takes it to 0.25, the second takes 0.5 and so on. The very last reading is 2.00, reflecting the 200 basis points of cuts we've had so far.
When it changes direction, it just returns to zero and kicks off from there.
That's the first thing.
The second thing is I wanted to account for the time lag between when interest rates start falling and when prices start picking up. Seems that there's a bit of a delay. I guess it takes people a while to start adjusting their plans.
I tried a few ways, but it looks like if I let interest rates lead prices by about 3 quarters to a year, the timing matches up pretty well.
With both of those adjustments, this is what we get:
You can see it's now a much closer fit.
It's still not water-tight, obviously. It gets a lot right. It nails 5 out of 8 turning points. But it does miss three. I'm ok with that. As I said, interest rates dominate price movements, but they're not the only factor affecting house prices.
But the interesting thing here is if you follow this model, it implies that house prices have a bit of catching up to do. And if it's to follow recent turning points, then we're probably looking at house price growth reaching about 15 percent sometime in the next year (just look at where the green line is now.)
And this makes sense. 200 basis points is a pretty aggressive run of cuts. You'd expect it to have a big impact on prices. 15 percent a year seems a reasonable result.
The question then is, are there any other factors that are going to stop us from getting there?
Well, as I've argued in other blogs, I reckon all the other factors that might influence prices – affordability, incomes, economic growth etc, are all exactly where you'd want to be.
Which means we could see even more than 15 percent!
Whilst ever one else tells you that this time its different… I think, he we go again and more importantly, what a great time it is to accumulate real estate and ride yet another property boom into the sunset… bottom line … I'm excited!
What about you ?