In today's Wall Street Journal, Phil Izzo wrote an article Housing Slowdown Takes Its Toll (subscription required).
"The housing correction is just in its early stages now," said Joseph Carson of AllianceBernstein, who forecast a 5% decline for 2007. "Existing home prices have come down to no-change on a year-to-year basis. For new homes, prices are below year-ago levels when you include added features. The prices will have to go lower to give demand a lift in short term."Mr. Carson expects broad-based difficulties throughout the nation. "Affordability is an issue across the board," he said, adding he believes a major correction is inevitable. "It's pretty clear now that national home prices will drop to correct housing imbalances," said Scott Anderson of Wells Fargo & Co.
Signs of cooling in the housing market have emerged in reports over recent months. Last week, David Lereah, chief economist of the National Association of Realtors, predicted that national median home prices will generally decline over the next few months. Although the group reported a slight increase in median home prices for July, it said that its index of pending home sales fell 7% in the month, the most recent figures available.
The big question is, will this housing experience a soft or hard landing? Doug Kass, general partner of Seabreeze Partners Management, Inc. and commentator for The Edge Column on Street Insight (subscription required) believes housing will experience a hard landing. He along with Bill Fleckenstein of FleckensteinCapital.com (subscription required) are the most bearish on housing, which is not surprising given that both run short hedge funds. That said, I find their logic that Greenspan by lowering rates excessively merely transferred the bubble from the stock markets to the housing market.
Others point to the very low unemployment, continued job growth, international economic expansion, and continued low interest rates as reasons for optimism. Perhaps, but if housing does experience a severe correction, then I suspect unemployment will increase substantially and the U.S. economic engine will stall. Usually when the U.S. stalls, many of its major trading partners also face difficulties. And the effects will ripple outward to other countries.
My sense is that investors are becoming increasingly concerned with the housing market and that is the reason for the softness. Yet, option volatility is near year low values, which does not fit the pattern. If investors are growing more concerned, I would expect option volatility to spike upwards as option prices increased. But we are not seeing strong evidence of fear yet.
In this week's Barron's magazine, Sandra Ward interviewed, J. Kyle Rosen, President, Rosen Capital Management for the article Time to Bet Big on Options (subscription required).
How does all this fit with your notion that the next 12 to 36 months will be one of the best for options?We've seen how quickly risk can be repriced. We will see a lot more of that, and there will be some wild swings back and forth. But across the board, risk premiums have been taken down to almost zero.
In options, a simple historical analysis of reversion to the mean shows implied volatility has averaged around 20% in any rolling three-, five-, 10-, 15- and 20-year period since options have been trading. Now we are hovering around 12%, a 40% discount just to the average. Even if we get back to the average, a lot of money can be made trading volatility. As implied volatility has been coming down near all-time lows, actual volatility has been creeping up.
Adam Warner over at daily options report wrote an excellent follow-up piece Stop Trading!
I covered a lot of ground in this article. To summarize, the current housing data is showing that the housing market is weak and may portend to a hard landing. The markets recently have been rather anemic, which I suspect is in large part to investors becoming increasingly nervous about the economy as a result of the weak housing market. Although I expect that investors are growing increasingly anxious, the options volatility does not seem to support that assertion because volatility is extremely low. Because options are under priced with the low volatility, now might be a good time to purchase options. Please see the Barron's article and Adam's follow-up. With regard to the stock markets, I remain cautious.
Leave a comment