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Let The Viewer Beware – Case Shiller Lags and Understates the Bubble

Case Shiller Vs. NAR - Click to enlarge

Here’s how the Case Shiller Index (CSI) press release spun the data on the state of the US single family housing market today:

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, covering all nine U.S. census divisions, reported a 5.1% annual gain in June, unchanged from last month. The 10-City Composite posted a 4.3% annual increase, down from 4.4% the previous month.The 20-City Composite reported  a year-over-year gain of 5.1%, down from 5.3% in May.

The problem is that Case Shiller’s methodology causes price suppression and severe lag. That gives the impression that the US housing market isn’t in a bubble. It’s a misimpression, considering that market prices on average are actually above the 2006 bubble peak. If 2006 was the top of the most extreme bubble in US history, what does that make today’s higher prices?

Case Shiller uses only public record data. The current release, which purports to be June data, is really data culled from government records for recorded sales. The closings were purportedly in June, but the contracts were entered at least a month before, and in most cases 2 months to 3 months prior. So the current CSI release doesn’t represent the current market.

In fact, the lag is even greater than that. Case Shiller doesn’t merely use only the most recent month’s data, as you would think. It uses that month and the two prior months, so that effectively it represents average recorded closed sale prices for the 3 months of April May and June. It’s the average price as of the time midpoint of the period, in this case mid May. Add the typical 45-60 day closing and the current data represents contracts signed in mid to late March. It is now almost September. The Case Shiller data is from 5 months ago.

The housing market normally moves in very stable trends over years, if not decades, until there’s a crash. This lag factor isn’t too critical for those buying homes for their families to live in. It’s a little more critical for stock market traders and investors, because at major turning points, misleading data can lead to costly investing mistakes. For traders, using the Case Shiller data would be like making decisions based on where the 3 month moving average of the S&P 500 back in late March. Who would do that when current market prices are available?

It’s the same for the housing market. We have near current data on contract prices from both the NAR, and from the online Realtor firm, Redfin. The NAR compiles the MLS data on contract prices from the entire US and releases it within 30 days of the end of the previous month. Redfin compiles sales from 30 large US metros. So whereas Case Shiller is giving us a smoothed average price as of March, we have current actual prices as of July from both the NAR and Redfin. Apply a little technical analysis to that data, and we can see the state of the housing market as of last month, not 5 months ago. It has actually accelerated a bit this year relative to the prior 12 months. And it’s definitely at a new high versus the last bubble.

Case Shiller Vs. NAR - Click to enlarge

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Three things are clear. First, house prices are continuing to inflate at a pace far exceeding the gains in household income. This trend can’t be sustained forever. The longer it goes on, the more dangerous it becomes as fewer and fewer potential buyers can afford the price of a house.

Second, at the price bottom of the housing crash, Case Shiller was 6 months behind the NAR data in reflecting the turn. The NAR data began making higher highs in March 2012, with a slight increase over March 2011. By April and May of 2012 it was clear that the turn was accelerating. The Case Shiller Index didn’t first make a higher high until the end of February 2013, upon the the release of December 2012 data. Robert Shiller himself was still cautious about whether the turn was real until well into 2013. Because of how the index is constructed, buyers were misled.

Case Shiller was more timely at the top of the bubble. The first evidence of a downturn was published in June 2007, with the data for the period ending in April showing a new low. The problem was that the market had begun to make lower lows in January 2007. If you were thinking of selling your house back then, by 2007 you would have been S.O.L. because by then demand had already dried up and sales volume had collapsed. Being able to sell your house at the high prices reported in 2007 would have been like winning the lottery.

Relying on Case Shiller for an indication of when to sell, is a dangerous game. Even the NARs home sales data was too slow to help you in 2007. But its volume data would have alerted you in late 2006 that the market was quickly drying up. Case Shiller gave you no such opportunity.

Finally, the other problem with Case Shiller is that in addition to being painfully behind the current market time wise, it also suppresses prices in rising markets. While the NAR data for all single family MLS sales in July showed prices 6% above the bubble peak, Case Shiller presents a picture telling everyone to “Relax! Relax! There’s no bubble. There’s nothing to see here, move along.” Prices are still 9% below the bubble peak.

MLS compiled national data has the law of large numbers working in its favor to take care of any anomalies. It reflects whatever buyers are buying and paying at that time. That’s the market. Yes, tastes change, new houses get bigger and buyers pay more for them. Fewer houses are sold at lower price ranges. Again, that’s how markets work. New cars have more gadgets than they did 5 years ago. Do we adjust prices for that? The price that people pay today for the utility of owning their own home is 6% higher than at the top of the bubble.

Case Shiller uses desperate economic thinking to torture the data so much that it doesn’t reflect the current reality of what people pay for houses today. In addition to the severe lag which leaves it showing the market level as of 5 months ago,  it uses paired sales methodology, which suppresses the average price of the index. It only shows the price levels of old houses that have sold before. To be included, in addition to the current price, the house must have sold previously at least 6 months ago, and up to as far back as 15-20 years ago. They claim to make statistical adjustments for deteriorating condition, but they also remove from the index all new houses and all flipped houses that have been renovated.

The logic for excluding flips escapes me. They’re part of the current market, the most expensive part. What, there were no flipped houses in 2006 and 2007? Come on. Give me a break Professor Shiller. As a long time commercial real estate appraiser, and even longer time market trend analyst, I’m here to tell you that your methodology is garbage. The fact that your index shows the current price level being 9% below the bubble top is garbage. You have effectively removed the houses in the best condition, which bring the highest prices, from your index. So its current level is below the level of where it would be if the newest, best properties were not systematically removed. The Case Shiller Index does not represent the whole market. It’s the This Old House Index.

This is dangerous because the clueless or complicit financial “news” media makes this index the go-to for the state of the housing market. Because housing price trends are very long and normally very stable, Case Shiller can appear to be reflecting the trend correctly for years, but it doesn’t show just how far the current bubble has progressed, and it doesn’t show the turns until well after the fact. By that time it is usually too late for both home sellers and often for stock market investors, with traders particularly at risk of damage if they believe these numbers.

Shiller bailed on the index and the idea of a futures contract tied to it, years ago. He sold it to the biggest boobs in investment analytics, the information marketing behemoth Dow Jones – Standard and Poors. They then sold it to Corelogic, the big real estate analytics firm that’s really just another data marketing outfit. For some reason it has become a hot potato, but the media still loves it. Let the viewer beware.

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