Housing bears immediately tried to poke holes in the surprisingly good numbers in the May Case Shiller report.
The most widespread bear argument, that the rise was just seasonal, is weak: Even the seasonally adjusted numbers were the best in three years.
Two other arguments, however, are more persuasive.
Whitney Tilson of T2 Partners calls the May numbers “the mother of all head fakes.” He–and the two analysts below–think house prices will resume their decline in the fall. We’re in that camp, too…
Bear Case 1: The Seasonal Adjustments Are Too Weak
The first argument against reading too much into the May numbers, made by Calculated Risk, is that the “seasonal adjustment” factor used by Case Shiller is not strong enough. Under this theory, a more appropriate seasonal adjustment would have showed a steeper decline in seasonally adjusted May numbers.
To support this argument, Calculated Risk plots the non-seasonally adjusted Case Shiller numbers (blue) and the seasonally adjusted ones (red). He notes that, during the 1990s, the seasonally adjusted numbers smoothed the seasonal variations to a relatively flat line (as they should). In the nutty 2000s, however, the seasonal adjustments produced wild swings that almost tracked the non-seasonal adjustments–thus defeating the purpose of attempting to “seasonally adjust” the numbers at all.
Thus, in Calculated Risk’s opinion, house prices will start falling sharply again in the fall, when the seasonal boost peters out.
Bear Case 2: It’s Just A Mix Issue
The second bear argument, made by Mark Hanson, is even more persuasive. In a nutshell, Hanson argues that the strong Case Shiller numbers were just due to a temporary seasonal change in the mix of houses sold–with “organic sales” (normal, voluntary, free-market sales) becoming a larger percentage of the overall sales than they were in the winter, when distressed foreclosure sales dominated.
In 2008, Mark’s argument goes, foreclosures climbed steadily through the year. Most foreclosures in 2008 were on lower-end, subprime houses that plummeted in price as banks dumped them at distressed prices. This year, however–at least in California–foreclosures have stayed relatively flat (at a high level).
Meanwhile, the organic sales market–sellers who actually want to sell–picks up each summer. In recent years, with most foreclosures taking place at the low-end of the market, the organic sales market has tended to include higher-priced houses that aren’t sold in distress.
Last summer, rising low-priced foreclosures overwhelmed the seasonal spike in high-priced organic sales, so average houses prices kept falling. This year, however, with flatter foreclosures, the seasonal spike in organic sales is having a far larger impact. Thus, in the past few months, the median sale price has risen.
In other words, Hanson attributes the rise in the Case Shiller index to a seasonal mix issue, not a bottoming in national prices.
Here’s Mark’s argument in detail:
[The numbers here correspond to the numbers on the chart below, which is data from California only]1. Previous to 2007, organic sales were the housing market. Foreclosure-resales made up 5% at most.2. Prices were at a peak through mid 2007.3. Foreclosure resales (sold through a realtor channel) began infesting the mix — organic sales and median prices began to drop sharply.4. Foreclosure resales keep rising for over a year while and prices continued to fall as the median price was pulled towards the foreclosure-related resale market price. In September 2008, they overtake organic sales. By Nov 2008, foreclosure resales peaked due to maximum demand from investors and first timers, foreclosure moratoriums, etc.5. In Jan 2009, after a 55% house price drop, median prices level out as the early purchase season begins and organic sales begin to increase. Additionally, foreclosure-related resale inventory has been held artificially low due to moratoriums and/or servicers keeping inventory off the market on purpose. In April 2009, CA median house prices bottom.6. Going into the busy season, organic sales bounce hard (just like they did the year prior), hit an inflection point in May and reclaim the mix in June.7. Median house prices began to turn upward in May — moving toward the organic market price — shortly after organic sales began to reclaim the mix. (See pink line leading yellow line beginning at ‘6’.
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