Irrationality: A Tale of Two Markets

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The Great Recession has obviously left a huge imprint in the mindset of the people who lived through it. At the heart of the boom preceding the recession was a virtuous cycle. Lenders, realizing that home prices have never dropped year-over-year at once across the United States, wanted to extend credit to home buyers in a chase for yield in the low rate environment of the early 2000s. Home buyers were happy to oblige as the cost of home ownership vs. renting decreased and they too realized the benefits of rising home prices. As prices rose, these buyers looked to cash out either by drawing the equity out of their property via a refinance or by selling the property to yet another lender-backer home buyer. All of this proved to be a boon for all parties until it wasn’t and home prices finally fell.

The fall was devastating. The global economy was plunged into a recession. Homeowners defaulted on their loans, banks collapsed, politicians pointed fingers, and central banks had to step in to provide necessary market functions to keep the system alive. The recession cost the United States 5+mm jobs and left participants shell shocked.

However, markets have taken different trajectories since the recession. The housing market obviously took a beating from which it has yet to recover. 400k-500k new 1-family houses used to pop up every quarter from 2005-2006 while right now just 90k are built every quarter. The Case-Shiller Price Index, which measures home prices in 20 metro areas, fell from a peak of 206 in 2006 to 138 in March 2011 and is still posting new lows. On the other hand, equity markets worldwide have rebounded since the recession driven by growth in corporate earnings as well as the ability for corporations to once again tap credit markets. The S&P 500 which peaked at 1550 in late-07 fell to 680 at the height of pessimism in early-09. Now, it sits cozily at 1300, just a -16% discount from its peak.

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Posted: June 4th, 2011
at 12:37pm by mnp

Categories: blogs,trade

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