"Observed Price Movements:" Buying High and Selling Low

I got into an on-line argument the yesterday with a guy who said the Case/Shiller numbers and the OFEO numbers were inconsistent, so you should ignore both. I couldn't believe the guy, an investment manager, could even compare pencil-pushing government figures with data from a brilliant Ivy League professor acknowledged to be at the top of his profession. I think Shiller is great, and I take every opportunity to read anything he produces.

For a quality article on how the government's inflation figures would look if Case/Shiller replaced rent-equivalency in the calculations, see http://www.iaconoresearch.com/. As usual, the government's numbers suck. Interestingly, the article shows that inflation was running at about 10% with Case/Shiller included, but that now it's dropped to negative if you include the Case/Shiller figures. A much more informative statistic than the one the government offers.

But it got us to thinking about one of Robert Shiller's best books, Market Volatility ('89). So we checked in on the chapter called The Behavior of Buyers in Boom and Pre-Boom Markets. In 1988, the authors sent about 20-page questionnaires to 500 people in four cities. Two of the cities, Anahiem and San Francisco, had booming real-estate markets at the time. One city, Boston, was starting to fall after it's boom. And the other town, Milwaukee, was neither boom nor bust.

Here's one of the main questions the authors wanted to answer:

1) "What causes sudden and often dramatic and sustained price movements? Although questionnaire survey methods can never provide a definitive answer to such a question, they can provide information that helps us begin to understand the process: What are home buyers thinking about, and what sources of information are used to decide how much to pay for a house? How motivated are they by investment considerations, and how do they assess investment potential? Is destabilizing speculation affecting house prices?"

Sounds like what we just went through, doesn't it? Remember, this was written almost 20 years ago. I'll check this week to see if they've done an updated study. Just check out the authors' conclusions. and see if those don't fit this time around, too. It should influence your opinion about where we're headed.

"First, virtually every buyer in our California cities and the vast majority of buyers in Boston and Milwaukee believe that prices will rise...The average annual increase for buyers in California was in the 15% range, while for Milwaukee and Boston, the figure was roughly half as high... Even in Boston, 77.8% reported that it was a good time to buy because prices were likely to rise in the future. For Milwaukee the figure was 84.8%, while it was well over 90% in both California cities."

Again, sounds like our situation. In California, prices took a turn for the worse the next couple years after this article. Now, over the 15 years since, I bet we've reached those expected returns (not compounded). For now. It took an amazing run the last few years to get there, and now we're due to give some back. Back then, they didn't have the loan-quality problems we're facing now. Here's more:

"Since most people expressed a strong investment motive, one would assume significant knowledge of underlying market fundamentals. The efficient markets hypothesis assumes that asset buyers make rational decisions based on all available information and based on a consistent model of underlying market forces...The survey reveals little knowledge of, or agreement about, the underlying causes of price movements. Rather than citing any concrete evidence, people retreat into cliches and images."

"In all four cities, interest rate changes are cited as a major factor...It is hard to understand how price changes in all four cities can be driven by interest rates."

"Second in overall frequency were general comments about the local economy, such as 'strong local economy' or 'growing regional economy'...The response to questions in this section leave the strong impression that people look to observed price movements to form their expectations and then look around for a logic to explain and reinforce their beliefs...Irrelevant stories that make a vivid impression tend to be cited."

"Among the most popular cliches were 'The region is a good place to live' and 'There is not enough land.' Neither of these is news and neither could explain the sudden boom...Very few people mentioned these cliches in Milwaukee."

You can expect Shiller's conclusion to hold when the housing market starts to retreat. When home prices start to fall, the "observed price movements" will cause more selling. Most people buy high, and sell low. Once this phenomenon starts spreading to the housing market, you'll see that we have a serious problem on our hands. We've done the buy high, there's only sell low left.