Wednesday, September 10, 2008
Yesterday, the pending home sales report showed a 3.2% decline in homes sales that have gone under contract but have not yet closed. The National Association of Realtors initiated this series in 2001 to provide a leading indicator of housing market activity. I find that the pending home sales index is not a good indicator of existing home sales (a measure of market activity). Further, the markets over-reacted to the report, as the takeover of Fannie Mae and Freddie Mac has certainly changed the playing field in the mortgage market.
In this decrepit housing market, investors are looking for any sign of a bottom in home sales, and markets didn’t like the pending home sales report. According to MarketWatch: “U.S. stocks churn as investors digest data on pending home sales and wholesale trade, with equities failing to extend the prior session’s sharp gains tied to the federal rescue of mortgage giants Fannie Mae and Freddie Mac.”
The number suggests that a bottom in the housing market has not been found, but does it really? Typically pending home sales take 1-2 months to close, so the July index points toward housing market conditions in August or September. However, the data suggests that pending home sales are not a good predictor of future existing home sales.
Chart source: National Association of Realtors; Nontruths Research
The charts show that there is a very weak correlation between the change in pending home sales and the change in existing home sales at one and two months in the future. At a one month lag, there is a positive relationship, but the relationship hardly fits the data well (R2 = 0.2395). The relationship is an even worse fit at a two month lag. Anything can happen in the existing home sales market; the fall in the pending sales index does not indicate that existing home sales will decline in August or in September.
Going forward, the U.S. government’s takeover of Fannie Mae and Freddie Mac has certainly changed the playing field in the housing market, hopefully for the better. Now that the secondary mortgage market is propped up by the U.S. Treasury, mortgage rates have a pretty good chance of remaining at the 6%-level, which will certainly bring potential homebuyers to the market. And if rates fall further (the spread between mortgages and treasuries is still pretty wide, give that the Fed has lowered its target rate by 3.25%), home sales will decidedly bottom sooner rather than later. Of course, the biggest risk remains that mortgage rates will rise again in spite of the takeover.
Only time will tell, but one thing is for sure: The takeover of Fannie Mae and Freddie Mac is a better indicator of the housing market going forward than is the pending home sales index.
Please leave comments. Best, Rebecca Wilder