The problem is that they think micro, and speak macro.
Micro helps with the supply curve. And the demand curve. Where do they intersect?
Honeymoon in Vegas: Inventory?
Getting away from traditional thinking is difficult. Sometimes it helps to start with an outrageous example. My nomination is Sarah Jessica Parker in the movie, Honeymoon in Vegas. This movie is a lot of fun -- well worth the DVD rental. The basic plot is that a guy wins $65K in a poker game (contrived) with another guy and agrees to cancel the debt for the creditor's weekend with his fiancee.
Simply put, she was not "in inventory" before this offer. But everything has a price -- maybe. Roger Ebert is our go-to guy on movies and he gave this one 3 1/2 stars.
The point? There is always "inventory away from the market."
Application to Stocks
There is "inventory" of any stock. Let's take Apple, Inc. (AAPL) as an example. It is a stock which we own for both individual accounts and institutions. Let us suppose that our fair value for Apple is 220. We would be sellers if that level were approached, and buyers at a lower level. We have a wide market. Other Apple investors have different markets. Each day's trading reflects the current market for the stock.
The individual demand and supply curves are a function of microeconomics. The intersection of the curves is a macro phenomenon. To understand stocks means knowing both.
Application to Housing
The current discussion of housing seems to confuse the micro and macro. There is much attention paid to housing that is "in inventory." Today's report on home sales and prices provided the information that there is currently a 10.6 month supply, arrived at by taking homes offered for sale and dividing by the current annual rate of sales.
The consensus interpretation of these data is that these homes will remain on the market until sellers get more realistic about pricing.
Errors in this Approach
The standard approach to the housing market has two conceptual errors. Let us illustrate this by looking at our own neighborhood, consisting of four-bedroom homes with family rooms, fireplaces, large master suites, dens, and a community geared toward safety for kids and good schools.
As children get older and leave for college, the empty nesters offer their homes for sale. They have a price in mind, but they are not forced sellers. They may be thinking of buying a retirement condo at a similar price. There are other sellers who have new jobs in another community. They are more motivated sellers.
Let us suppose that homes are selling at a price of $500 K.
The inventory errors are twofold and conflicting:
- It understates inventory "away from the market." Some (non-motivated) sellers have offers at $550 K. These homes are not trading. If prices approached this level, there would be a lot more inventory! Many people who know that the price is unrealistic have not listed their homes, but would do so if prices moved higher. This suggests that the quoted "inventory" figures are understated.
- The analysis assumes static demand. The measurement of inventory depends upon the current rate of sales. Anything that influences demand would dramatically change the months of supply. The demand curve would respond to several factors, including a perceived stabilization in pricing, strong government programs to aid buyers, or improved availability of mortgages. There may be buyers at current prices if conditions changed -- a shift in the demand curve.
Many observers have noted that potential buyers are concerned about falling prices. They fear that buying now will leave them under water in a few months. These people are qualified buyers who are not willing to "pull the trigger" until they see stability.
The demand picture is also influenced by the limitations on available loans. Any moves to increase lending power -- more capital for lenders or a resumption of securitization -- will shift the demand curve.
Higher prices will bring out more sellers. There may be much more inventory at higher prices -- inventory not reflected in current listings.
The typical analysis one sees in the financial media takes a superficial approach. It assumes that all inventory is "real" and does not consider either "latent supply" at higher prices nor "latent demand" at current or lower prices.
Investors interested in housing problems -- and we all should be -- must consider how both supply and demand curves will change in a dynamic environment. Looking only at the apparent supply, and assuming that sellers will eventually reduce price offers, is a mistake.
We are not selling Apple at 185....
Any analyst not looking at both supply and demand curves, and potential shifts, is not giving a complete picture.