The Theory of Two Bottoms

• June 17th 2009

by Will Smith

UrbanTurf usually avoids publishing dense statistics and economic analysis about the state of the housing market. But we saw something yesterday on the widely-read Calculated Risk blog that we believe warrants coverage here. It’s the theory of “two bottoms” in the housing market.

You’ll recall that yesterday’s surprisingly positive numbers from the Commerce Department — housing starts and building permits both beat analyst estimates — led many pundits (including Jim Cramer) to proclaim that the housing market has bottomed.

Well, not so fast, says Calculated Risk author Bill McBride. McBride espouses the view that the national housing market will reach two bottoms at two different times. The first bottom is the activity bottom; that is, when activity like housing starts stops falling and stabilizes. The second bottom, which comes later, is the pricing bottom, when home prices stop falling and stabilize.

McBride believes that the bottom we may be seeing now is the activity bottom, not the pricing bottom. In fact, he argues that prices could continue to fall for at least another year in the worst cases.

Why is the distinction between the activity bottom and the pricing bottom so important? Because you (the home buyer or home seller) likely care most about the market value of homes so that you can have a sense of whether prices are going down, up, or sideways. Home prices are what affect your net worth, the size of home you can afford, the profit or loss you will take if selling your home, etc. The activity statistics — housing starts, new homes sales, residential investment — are important economic indicators but are less immediately relevant to John and Jane Doe deciding whether to buy a home right now.

Keep in mind: the “two bottoms” theory is just that, so there are surely analysts and market watchers that may disagree with the concept. (Though McBride provides very compelling historical evidence for it.) The important thing is that when you hear the economists and pundits talk about reaching a bottom, confirm whether they are talking about a bottom in housing activity or housing prices. Because as McBride argues, “These bottoms could happen years apart!”

To learn more:

• Cramer Gets Confused on Housing
• More on Housing Bottoms

This article originally published at https://dc.urbanturf.com/articles/blog/the_theory_of_two_bottoms/1040.