Blog - Investing Notes

July 16, 2009 - Update: 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 may 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 (2005-2008) and contemporaneous annual S&P 500 Index data for 1968-2008 (41 years), we find that:

Note that 2005 data is no longer available via the second source, so we use data collected for a past review.

The following chart shows the behavior of the median sales price for existing homes in the U.S. and annual closing levels of the S&P 500 Index over the entire sample period. Both series generally increase, home prices much more smoothly than stock prices. The average annual increase for home (stock) prices is 6.0% (7.1%), and the standard deviation of annual changes in home (stock) prices is 4.7% (17.6%). The housing price bubble emerges in the last six years of data. Visual inspection is unhelpful in discovering any specific relationship between median home price and stock index level.

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

The following scatter plot relates the annual change in the S&P 500 Index to the same-year change in the median sales price of existing U.S. homes over the entire sample period. The Pearson correlation for the two series is 0.12, offering a very slight indication that the stock market is stronger (weaker) when home prices are stronger (weaker). However, the R-squared statistic for the two series is just 0.01, so variation in home appreciation explains only about 1% of the variation in stock returns.

For a different perspective, we try a ranking approach.

The next chart shows the average annual S&P 500 Index returns during the 10 individual years out of the entire sample when home appreciation is lowest, moderately low, moderately high and highest. The irregular progression in average stock returns tends to confirm the low correlation found above, but a lower half/higher half perspective offers support for a belief that homes and stocks may be more competing than reinforcing investments.

Might home appreciation systematically lead or lag stock returns?

The final chart relates annual changes in home prices to stock returns for various lead-lag relationships over the entire sample period. Results suggest a weak three-year to four-year cycle of interaction between home appreciation and stock returns. Specifically, high (low) stock returns three to four years ago weakly suggests weak (strong) home appreciation now. Similarly, strong (weak) home appreciation now weakly suggests low (high) stock returns three or four years from now.

Note that the sample is very short in the context of analyzing multi-year cycles.

In summary, data from the past 41 years indicate little or no contemporaneous relationship between the equity market and the residential real estate market. There may be a weak, inverse, multi-year relationship between home appreciation and stock returns.

See Richard Beddard's prior discussion for other perspectives on home prices and stocks.

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