The long-term evolution of consumer prices partially defines the fundamental environment for stock prices. When consumer prices for various goods and services have different but sustainable trends an opportunity arises for long term investments. Observations show that some of these sustainable trends have clear turning points which provide investors with invaluable information on buy/sell decision. In this article, we investigate the past and future evolution of the consumer price index (CPI) of housing and demonstrate that it will likely be falling till 2021.
Four years ago we published a paper on the presence of long-term sustainable trends in the differences between various components of the CPI in the USA. We started with the difference between the core CPI (i.e., the CPI less food and energy) and the overall CPI. Then the consumer price index of housing, which comprises approximately a half of the headline CPI, was analyzed. In the beginning of 2008, we successfully identified a turning point in the difference between the CPI and the housing index and predicted the housing index to fall relative to the CPI during a lengthy period of eleven years. Here we revisit this prediction and demonstrate the turning point timing and the duration were almost exact.
Figure 1 displays the evolution of the difference between the CPI and the housing index (both seasonally adjusted) since 1967. The BLS started reporting on the hosing index in 1967. There are distinct time segments with the difference growing and falling at approximately the same pace, except the period after 2008.
Figure 2 shows three consequent quasi-linear trends in the difference with the relevant regression lines and equations. These regressions are characterized by higher coefficients of determination, R2, between 0.76 and 0.93. The current trend has been evolving since July 2008. Considering the current trend, we expect that the housing price index will demonstrate negative growth relative to the overall CPI, which includes the housing index by definition.
There are two CPIs (food and energy) which are often excluded from the overall CPI in order to remove high amplitude fluctuations and to obtain a smoother long-term estimate of consumer prices. It is instructive to compare the housing index with the core CPI. It should be noticed, however, that some portion of the index of energy is included in the housing index. Another improvement might be achieved when the core and housing CPI difference is normalized to the core CPI. This ratio removes the dependence on the index level and thus provides a more reliable estimate in terms of econometrics (effectively, we reduce an I(1) stochastic process to I(0)). Figure 3 depicts the difference between the core CPI and the CPI of housing normalized to the core CPI. The trajectory of the normalized difference is much smoother and demonstrates sharp turning points, with the latter in June/July 2008. Moreover, all regressions are characterized by higher R2. Interestingly, the slopes have a tendency to increase in absolute terms: from 0.0062 y-1 to 0.0086 y-1. The relative rate of the housing index fall is now 40% faster than that between 1986 and 1996.
Having these rates of the relative price growth one might be interested to estimate the length of the current trend and its peak value. Figure 4 presents such an estimate based on the naïve assumption that the future repeats the past. (Figure 5 illustrates the possibility of sharp timing of the turning point.) The red line in Figure 4 repeats the difference (black line) shifted by 26 years. If the past pattern will be repeated in the future one may expect the relative fall in the housing index will extend into 2021.
Concluding this short study we would like to highlight two principal findings related to investors. First, the good and services included in the housing index will be growing at a slower pace than those related to other categories of CPI. Second, this situation will last longer than a few years and will likely end only after 2021. We will revisit the difference between the core and housing CPIs in several months.
Figure 1. The difference between the headline CPI and the CPI of housing.
Figure 2. Linear trends in the difference between the headline CPI and the index of housing.
Figure 3. The difference between the core CPI and the CPI of housing normalized to the core CPI. Three distinct periods with sustainable linear trends are marked with the relevant regression lines and equations.
Figure 4. The difference between the core CPI and the CPI of housing normalized to the core CPI. Red line is the difference shifted by 26 years ahead.
Figure 5. Same as in Figure 4 between 2000 and 2015.