OK, here I go with another educational concept that has no immediate and actionable investment advice. I heard a couple of uninformed comments about housing. One was that the market needed to push prices down so that it would clear. This reflects ignorance. Markets clear at the current price.
The other was about shadow supply. Let's take a closer look.
BackgroundForget the fact that nearly everyone is telling you something completely bogus. Accurate analysis requires several things:
- A willingness to be led by data, not by pre-conceptions;
- A strong analytical method;
- Good data.
Sometimes in classes I would introduce a diversion -- an example that was easily understood and avoided the current bias. Let me take a swing at that here.
Oil producing countries are always pumping. If the current spot market demand for oil does not produce a high price, the producers do a calculation. How much would it cost to store oil, either on tanker ships or land-based facilities? Is the expectation of a future price high enough to justify the storage costs?
This is a calculation done daily in the sophisticated energy markets. And why don't the producers just stop producing? It is costly to do so. They have high fixed expenses. They make a calculation, at the margin, about what to produce.
This is a pretty simple conclusion. The oil producers have a supply of oil available at a price. The specific price depends upon many factors including their own cost of carry and production expense. These are all profitable and savvy market participants.
The result is a supply curve for oil -- a classic economic outcome. The higher the price, the more oil will be delivered. Is this a surprise for anyone? It is what you would expect from your intro Micro-economics class.
Let us now shift to an environment where the punditry holds suppliers in low esteem -- the housing market. I suggest that readers review the last paragraph substituting homeowners or home builders for the oil producers. I hope you see the trap.
We are trained to think of one group as smart and the other as dumb. In fact, both groups are operating in line with economic principles.
Shadow Supply ----- and Demand
This is an important subject. Many of the most popular talking heads are doing frequent pontificating without passing the chalk test -- they could not draw and analyze a supply and demand curve.
The pop economists do not understand distributions. For them, there is no supply curve. It is just a static inventory of homes that must be sold. In fact, the extreme part of the curve reflects those who would sell if prices were higher, but they choose to wait. This may be a very rational decision.
Similarly, pundits do not grasp the demand curve. The extremes of the demand curve reflects potential buyers, who would buy if the prices were lower. Instead, they choose to wait.
Nearly everyone talks about the shadow supply, so it has become the conventional wisdom. Meanwhile, what about shadow demand? Here is something that you have not heard anywhere else:
...the Boomer Woman's household is quickly turning into a remake of classic television shows from her childhood, shows like "Petticoat Junction" or "The Waltons," where several generations of one family live under one roof – usually out of economic necessity.
Families are getting crammed together and it creates a lot of stress. It is pent-up demand, but you never hear about it. These families are in the market for new homes -- ASAP. It will not play out until employment improves, and it will be gradual.
But guess what? The supply effects are also on a curve and will also be gradual.
The amateur and pop economists - -and that means nearly all of the most popular economic sites -- never discuss distributions for supply and demand. Anyone who discusses supply and demand without reference to a distribution and a shifting curve is not really analyzing.
This topic clearly requires more analysis of specific contentions. It may be good for a face-off.