Blog - Investing Notes

June 12, 2007 - Home Prices and the Stock Market

Reader Richard Beddard, editor of Interactive Investor, inquired about the relationship between home prices and stock prices, citing concern that weakness in UK and US residential real estate markets will adversely affect stocks. Does weakness in home prices portend a decline in the stock market? Using annual median home price data from RealEstateABC.com (1968-2004) and the National Association of Realtors (2004-2006) and contemporaneous annual S&P 500 index data for 1968-2006 (39 years), we find that:

Even though RealEstateABC.com cites the National Association of Realtors as its source for home price data, the 2004 median existing home price differs for the two sources. We choose the 2004 value from the latter since it is the original source. The difference indicates a potential data quality problem.

The following chart shows the behavior of the median sales price for existing homes in the U.S. and the S&P 500 index based on annual data for 1968-2006. Both series generally increase, home prices much more smoothly than stock prices. The average annual increase for home (stock) prices is 6.6% (8.4%), and the standard deviation of annual changes in home (stock) prices is 3.8% (16.4%). Visual inspection is not helpful in discovering any specific relationship between them.

To examine the relationship more precisely, we compare annual changes in the two series.

The following scatter plot relates the annual changes in the S&P 500 index to the same-year changes in the median sales price of existing U.S. homes for 1969-2006. The Pearson correlation for the two series is -0.17, offering a very slight indication that the stock market is stronger (weaker) when home prices are weaker (stronger). However, the R-squared statistic for the two series is just 0.03, so variation in home prices explains only about 3% of the variation in stock prices.

During the 13 years that home prices are strongest (weakest), the average annual change in the S&P 500 index is 11.4% (6.2%). The average annual change in the index for the intervening 12 years is 7.6%. During the 13 best (worst) years for the S&P 500 index, the average increase in the median price of existing homes is 5.7% (7.1%).

Finally, we offset the two series such that changes in home prices lead or lag changes in stock prices by one to five years. We get the strongest statistics ( Pearson correlation -0.39 and R-squared 0.15) when annual stock returns lead home price changes by three years. The most appropriate notion may be that a relatively strong (weak) stock market offers some indication of relatively weak (strong) home prices about two or three years later. Some underlying business/inflation cycle may be responsible.

In summary, data from the past 39 years indicates at most a weak contemporaneous relationship between the overall stock market and the residential real estate market. If anything, there is a some tendency for stocks to be relatively strong (weak) when home prices are relatively weak (strong).

See Richard Beddard's broader discussion for related perspectives on home prices and stocks.

For analysis of other economic indicators, see Blog Synthesis: The Economy and the Stock Market.