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Cross Feedback Between the Stock and Housing Markets   (September 28, 2006)


In his classic text Irrational Exuberance (recommended here) author Robert Shiller posited a connection between the dot-bomb era stock market the ensuing housing bubble which he called cross feedback.

Internationally, home price booms show some tendency to peak a couple of years after stock market booms. This raises the possibility that there is sometimes cross feedback, that is, feedback from one market to the other, between the stock market and the housing market.

It does not seem surprising that a home price boom would begin a few years after a stock market boom... the greater wealth ought to encourage people to spend more on their homes, and thus bid up the price of homes. (page 78)
In other words, a stock market boom generates a "wealth effect" which crosses over to the housing market. Fair enough. But what about a boom which crashes back to earth, as the NASDAQ market did in 2000? Shiller's questionnaire-based research found that:



More than ten times as many (recent home buyers) said that the stock market encouraged them than said it discouraged them.



After we read such answers, some patterns seem to emerge. The drops in the stock market since 2000 and the failure of the market to recover had just gotten people increasingly fed up with the stock market, and ready to transfer their affections to another market, a market that they increasingly believed was the best investment for them. (page 80)


This cross feedback may seem blindingly obvious, but it does lead us to ask: what cross feedback might occur if both the stock and housing market roll over? Might the dropping of prices in both markets start feeding back to each other? Where will people put their money as both their stock and housing investments falter? Could the recent rise of the bond market presage a flight to the apparent safety of bonds?

The chattering classes are nearly unanimous in their expectation of deflation and a round of Fed rate cuts. Nice, but what if they're wrong? What if the inflation in non-discretionary spending and taxes which I have often described here (as opposed to the deflation found in discretionary items like restaurant meals) is embedded in the economy, merely masked by phony-baloney statistics which trumpet "inflation is dead"? What if the chart above reflects a reality which has been discounted, i.e. inflation is in a multi-year uptrend regardless of discretionary spending deflation?

In other words: what if the Fed can't cut rates, as universally anticipated? Then what happens to bonds? They drop like stocks and housing. This is the cross feedback trifecta no one anticipates--no place to hide except maybe--maybe--gold and silver.


For more on this subject and a wide array of other topics, please visit my weblog.

                                                           


copyright © 2006 Charles Hugh Smith. All rights reserved in all media.

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