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When evaluating where we are in the housing cycle, it is often useful to evaluate fundamental valuation metrics and compare current trends versus historical averages. Below is a graph (click to enlarge) depicting the national price-to-rent ratio, which depicts how homes are trading relative to their rental values. This metric is similar to the P/E (price/earnings) ratio typically used in analyzing the stock market.
This graph uses the Case-Shiller Composite 20 and CoreLogic House Price Index, and sets the baseline period at January 1998, which is assigned a value of 1.0. The current ratio (as of October 2011) on both indices is at 2000 levels, indicating that we are very close to long-run historic average metrics. While foreclosures/short sales (lagging economic indicators) still account for a significant share of existing home sales, the good news is that delinquency rates (leading economic indicators) are gradually diminishing. As such, we can expect home prices to bounce around gently for several months, then gradually start to recover based on improving fundamentals.
The Federal Reserve Bank of Atlanta reported as of Jan. 13 that it had completed $1.14 trillion, or 91%, of its planned $1.25 trillion MBS purchases. Per a separate update from the Federal Reserve Bank of New York another $12 billion was purchased last week, bringing the total to $1.15 trillion, or 92% of the total commitment. As planned, the program is set to reach its goal by the end of Q1.
So what’s the big deal? Well, the wind-down of this plan will show us just how effective the Obama Administration and Fed was at creating stability in the housing market. Unless we see continued commitment towards MBS purchases after this date (doubtful though not impossible) my prediction is that mortgage rates will rise nearly half a point and, together with expiration of the Homebuyer Tax Credit, will lead to further deterioration in the housing market.
Here are the links to the Fed data: