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Introduction
The current global financial crisis has led to an increasing number of market and financial analysts studying the relationship between the housing markets on the one hand, and the prices of stocks, on the other hand. When the housing market slowed down, there was also a corresponding decline in the stock market. Accordingly, this research paper aims to assess the impact that the housing market has had on the stock market. An in-depth examination of the housing market, along with an exploration of the stocks market, is necessary to shed light on the relationship between these two markets.
The housing market
The housing market is the investment in real estate where people invest in houses and homes. It involves the demand and supply of houses and the variation in their prices. Various factors determine the housing market, and these include consumer income, demographic factors, costs involved, and prices. In the US, this market is growing in value and most of the citizens draw their income from it. Many investors view this market as the best form of investment since it has high returns.
On the other hand, the housing market is a market where the public can buy the stocks of different companies are bought and sold at agreed prices.
Stock market
Public stocks listed on the stock exchange market belong to corporations whose specialty is creating a market for securities. This is the main source of income for many companies since they can raise capital with ease. They offer liquidity to their investors while the housing sector is an investment that provides less liquidity compared to other securities. Stock markets determine the status of the economy in terms of development. They affect wealth distribution and the levels of consumption in the economy. Increases in stock prices show that the economy is growing. This market is very volatile, given that its operations depend on the speculations established by financial analysts and investors.
A boom in the stock market is evident in the rise in the stock market because when a crisis hits the economy, both the stock and housing markets decline. The lending to finance house building has become tighter and as a result, more challenges could affect the housing market since most of the people are experiencing home closures. Home sales are declining and as much as the stock prices are improving, home sales are shrugging behind. In California for example, foreclosures have increased, and shortly, home auctions could increase. This drop in the housing sector will affect the stock market and consumer spending shall decline (Palmeri par. 2-4).
Impact of the housing market on the stock market
There is a relationship between, on the one hand, the stock market and on the other hand, the housing markets, as both have price linkages. The appreciation in the stock prices causes the prices of the houses to rising in the short run. Since 1993, the relationship between the stock and market prices has weakened and there has been a structural break between them. The housing market has been performing better compared to the stock market over a long period meaning that this could be a wise form of investment. Investing in the housing market benefits not only an individual but also the society. Areas with high rates of homeownership tend to support the education of the populace and the crime rates are low. Getting money to finance housing is easy, especially when considering issues like mortgages. Institutions also offer loans at low-interest rates, making it simpler for people to finance housing investments.
The impact of these two markets may differ depending on the wealth distribution effects and, the effects on the consumption patterns. It is hard to track how the housing market is fairing because analysts do not monitor this market every day, unlike the stock market. The rise in housing wealth implies that young people will have to increase their savings so that they can be able to own houses in the future. People who hold stock are the ones who are greatly affected in their consumption patterns if the stock prices increases and, increases in housing prices affect the consumption patterns of homeowners, compared with tenants (Shiller 22).
The stock prices have declined because of the global economic and financial crisis and this could affect the housing market. The decline in share prices greatly affects the economy and the ability of financial institutions to lend falls. Consumer wealth falls when the share prices decline and this leads to a decline in spending. Since shares are a market based on speculation, it means that a fall in prices may not have any adverse effect on consumer spending. In addition, only a small percentage of the population hold shares therefore the housing market has not been greatly affected by the impact of the housing market. The confidence levels in the economic decline with a decline in share prices and if the prices of the houses fall, this could adversely affect the housing market. Thus, the stock prices affect the economy in a great way and if they are falling, the chances of a recession are likely to occur (Pettinger par. 2-4).
Investors are increasing in the housing sectors and this resulted from the high competition among investors and the fact that most financial institutions are offering finance to real estate developments. The lenders are offering loans to the homeowners who are undertaking construction since they are aware that their loans need repaying because this particular sector is characterized by a wide market. This is important so that households can get higher incomes. This causes the demand for real estate to rise, as many investors will want to own this asset. They do this without putting into consideration the real value of the asset and only base their decision on the rising prices. This has led to a rise in housing prices at a level where they are high than the inflation rates (Zhu 9).
Lenders start becoming more cautious when giving loans and they place tight lending rules. The fallout in mortgage loans may occur when the borrowers are not able to meet their debts and this adversely affects the stock market because it solely relies on speculation. Since expectations are low, there have been tight lending rules and as a result, the expectation is that there shall be increased foreclosures. This will have a great impact on the share prices because, when the expectations are low in the economy, the speculation is that share prices will not be doing well (Chelagat par. 6).
The decline in the housing markets has reached a considerable stage as shown by the Homebuilders Index in the chart below. In the chart, the correlation is about eighty percent between the housing and S&P 500. The housing market has affected the economy by about 57% in the period of the past five years.
The chart above represents the variations in the stock and housing markets for a period of ten years from 1996 to 2006. It tries to show whether there is any correlation between these markets. The vertical axis represents the market indices while the horizontal axis represents the years.
It is evident from the chart that the S&P 500 is revolving in the same area where the National Association for Homebuilders (NAHB) index is. It increased from the period from 1996 to 1999 and the S&P 500 increased. There was a rise in about 40% and in 1998 to 2002, there was a sharp decline in the housing index and the S&P 500 curve declined. Accordingly, there was an increase in the number of houses sold, up to 2006, when the housing sales drastically declined. This implied that the S&P500 curve may be expected to decline by about 42%. The chart above is an indication that the stocks held by the S&P 500 firms are varying as the housing index varies. The correlation between the two curves is 79% and this shows that there is a very high relationship between the stocks and housing markets. Investors cannot afford to assume this relationship and thus, they should come up with defensive means to safeguard their investments. It is evident that there is a correlation between the housing and stock markets because a sharp drop in the housing index was evident toward the end of 2007, when the prices of stocks also started to decline. At the same period, the stocks have been suffering a great decline because of the global financial crisis. Therefore, it is possible that the stocks followed the trend of housing index (Ciovacco par. 6-8).
If we use California as an example, in the Bay area, any variations in the stock market prices can cause changes in San Francisco housing market prices while the vice versa is not true. A change in the market prices has an impact in the prices of houses though it is low (Krainer par. 6).
California Median house prices:
Table 1: Source: Krainer, John, 2000, FRBSF Economic Letter
In the chart above, the X-axis represents the years from 1991 to 2000. The Y-axis represents the housing prices in the San Francisco Bay Area in thousands of dollars. The increase in house prices comes because of the Silicon Valley appreciation. From 1991 to 1995, the prices were in the same range and from that time, they rose drastically. Towards 2000, the prices of houses had drastically increased compared to the other years. The inclusion of the S&P 500 in the comparison of the prices in the years shows that there could be a relationship between housing and stock prices. A ten percent increase in the stock prices causes a two-percentage change in the housing prices. In the San Francisco Area, it shows that the housing market was doing well as the years moved on.
Increases in the prices of assets will have an effect initially in both markets and this generates an interaction between them. The reliance of the housing markets on the stock markets portrays that they are experiencing a financial deficiency. When using econometric models to determine the relationship in these markets, it is important to take into account the instability factor to avoid biases. People who invest in the housing market consider it more profitable than the stock market. In addition, the risk is less for those investors who have less liquidity and financial exploration. The volatility in these markets is the same and increases in the value of the property will be more valuable to the companies. This is likely to attract many people to the stock markets (Tong par. 12).
The housing prices may react to the expected incomes in the future, which also affects the consumption patterns at that time. In addition, the stock markets may lead to an increase in the prices of assets that leads to increased consumption, resulting in eased limits of borrowing. An increase in income also implies that the demand for houses shall also increase and this will, in turn, lead to a rise in the housing prices assuming that the supply of houses and consumption is constant. Since houses are assets that an owner may use as a form of collateral, house owners who are faced with borrowing problems, become more relaxed when the housing prices increases. This is because homeowners are in a position to increase their borrowing and enhance consumption. With the increase in the prices of houses, the money held in stocks increases, and people may opt to increase their consumption by reducing the money held in stocks (Paiella 3).
If the stock prices decline, the investors confidence declines, and people begin looking for alternative investment opportunities. People tend to shift their assets to the housing sector since the stock market is so volatile and many view it as an unstable form of investment. In addition, declining stock prices affect the distribution of wealth in the economy and this hurts those interested in houses. Since the increase in the prices of houses increases the value to the owners, homeowners could opt to view this as a sound investment, making people shift their investments from the stock markets.
As the investors decide to pull out of the stock markets to invest in safer investments, the huge sales in stock affect the stock prices and they tend to decline. The housing market may mislead investors because as much as it is profitable, it requires a lot of capital to establish and it leads the homeowners into huge debts. It means that the investors will cause a drop in the share prices if they decide to pull out to invest in real estate. With the current economic crisis, the sales and profits by investors are declining and the housing industry is facing a drop in its performance. The shrink in the housing sector adversely affects the economy leading to a decrease in the GDP and the circulation of money in the economy is low. This will affect the stock market, largely controlled by the status of the economy. If the economy is doing well, the stock market is also doing well, and vice versa.
Real estate in the US contributes about 10% to the economy and, the bubbles in this market; would cause a correction in the stock market. This means that the stocks would lose about ten percent of their value. If the bust continues in the housing market, it would result in a bear market when the markets are at their lowest levels. If this happens, the economy is likely to suffer a recession and this would adversely affect both the stock and the housing markets.
The interest rates in the economy affect both markets. If they are high, the costs of mortgage loans will be very high and this will mean that people will not borrow these loans. If they continue to increase, it will mean that those who own houses will be having problems with their mortgage repayments. This will force the homeowners to sell their houses so that they can get money to repay their loans causing a decline in the house prices. However, the effect could be mild if the demand for the houses is high, meaning that the interest rates will not adversely affect the housing market. On the other hand, high-interest rates affect the economic status causing a fall in the share prices. When the rates are high, people will borrow less and this means the money for investment will be less. If the demand for houses is high, it means that the homeowners will have more capital from this market. This means that they will prefer to save their money due to the high rates. They might end up investing the money in the stocks and this will make the prices of the stocks go up (Pearson par. 2-4).
Analysts use the housing market as a predicting indicator for the stock market. In New York, the stock investors are required to be cautious because of the weak housing market. The sales of new homes have dropped in the previous five months and this has led analysts to evaluate the stock prices. As the dollar is trying to strengthen and the prices of goods are declining, the weighted effect on stocks is high. Thus, investors can use housing prices in the stock market to speculate the expected effects. This will enable them to plan and have a plan of action on their investment patterns.
The global stock markets are at times low and other times they are high. Banks and other lenders use the global stocks markets while offering clients loans and mortgages, as they are an indication of the expectations of an economy. Fluctuations in the housing market affect investors in this sector of the economy because the lenders may view the declining prices in stocks as a risk in their loans. They predict that their loans might be defaulted thus they impose many restrictions in the lending process which are unattractive to the investors. However, the stocks might mislead them since these two markets do not always affect each other.
Conclusion
It would be right to say that the housing market affects the stock markets. This is evident in the present times that as the prices of houses fall, those of the stocks also decline. Investors have to make wise decisions when choosing the type of investment to make. Investors should put into consideration the status of the housing market when making decisions to invest in stocks. Since the volatility in the housing market is high, many prefer to invest in real estate but they must have adequate capital since they are expensive to establish. The housing market has more effect on the distribution of wealth and the trends of consumption. The change in the two features greatly affects the functioning of the economy. The stocks are very dependent on the economic status and any changes will affect the stocks. Analysts should pay close attention to stocks, as they are more likely to cause a recession if they continue to decline.
Works Cited
Chelagat, Misiko. Effects of housing on the stock market. American Chronicle. 2007. Web.
Covacco, Chris. Housing poses a significant threat to GDP & stocks. Ciovacco Capital Management. 2006. Web.
Krainer, John. Tech stocks and house prices in California. FRBSF Economic Letter. 2000. Web.
Paiella, Monica. The stock market, housing and consumption spending: direct wealthy effects, common casualty and borrowing constraints. A survey of the evidence. 2007. Web.
Palmeri, Chris. Housing and the stock. Business Week. 2009. Web.
Pearson, Chris. Effects of interest rates on housing and share. Economics Blog. 2008. Web.
Pettinger. Effects of a falling stock market on the housing market. 2007. Web.
Shiller, Robert. Comparing Wealth effects: the stock market vs. the housing market. Advances in Macroeconomics 5.1 (2005): 22.
Tong, Guangrong. Research of the dynamics of volatilities between stock market and real estate market. 2007. Web.
Zhu, Haibin. The importance of property markets for monetary policy and financial stability. BIS Papers No. 21, 2007. Web.
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