Sunday, May 13, 2007

Conspicuous Correlation

A lot has been made in recent years about the “wealth effect” associated to the unprecedented home value appreciation seen during the historic housing boom and its consequence on consumption and the general economy.

As the theory goes, as home values increase, homeowners “feel” wealthier, either directly through home equity withdrawal or indirectly by simply observing the increased value of their home asset.

The outcome is an increase in consumer confidence and, in turn, consumer spending, particularly on discretionary items.

Of course, this effect can work the other way as well, that is, as home values decline, homeowners, feeling a decline to their wealth, may pull back on spending.

It’s important to consider that, given the reckless lending and borrowing seen during the latest housing boom, it’s likely that consumers are not only going to feel their housing wealth decline, but also the burden brought by servicing their outsized debt obligations.

Either way, the “wealth effect” is a particularly important macroeconomic phenomenon as personal consumption accounts for over 70% of GDP.

So the key question is, has the recent decline in housing had a measurable effect consumer spending?

The answer appears to lie in data released in the Census Debarments Retail Sales Report which tracks total receipts at stores that sell durable and nondurable goods.

To reveal the trend, I have combined several of the key, discretionary retail sub-category results into a single “discretionary” retail sales series, and then charted the year-over-year percentage changes since 2000.

I then added the year-over-year percentage changes of the S&P/Case-Shiller Composite index which broadly and accurately tracks single family home prices using data from Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco, and Washington DC.

The result is a significant correlation between the deceleration, and now outright decline, of home prices and a deceleration and subsequent decline in consumer spending.

The first chart (click for larger version) shows the complete series comparison from January 2000 to the latest reported months of 2007.

Note the precipitous deceleration and decline to home prices starting in January 2006 and the very well correlated decline in “discretionary” retail sales.

Also note that the latest decline to retail sales is easily the most significant and sustained seen since 2000, handily surpassing the decline that occurred during and preceding the 2001 recession.

The second chart (click for larger version) simply isolates the results from January 2006 in order to provide a clearer view.


  1. Anonymous1:05 AM

    Were the annualized changes really that high - ~14% YoY growth in sales in April 2004? I understand that both figures are subsets, but those are some wild-looking numbers.

  2. Remember,

    These are year-over-year percentage changes to just the most discretionary purchases.

    Consumer electronics, home and garden goods, sporting goods, music related items and home furnishings.

    These items will likely be the most effected by weakness in housing and a resulting declining consumer confidence.

  3. SATT,

    I would like to run some statistical analysis on this data, do you happen to already have it compiled? Email me at if you wouldn't mind.



  4. Anonymous8:47 AM


    Great blog,I was wondering about your opinion as to how, if any the stock market relates to what's happening in the US as a whole.I always hear financial talking heads try to explain the markets daily closing price with some corresponding info such as "the latest consumer confidence numbers are up/down" etc.We,as ordinary consumers,see what kind of effect $3.00+ gas,crashing real estate,etc has on our everyday lives,yet the market reaches new record highs everyday.Do you believe the stock market itself is in it's own bubble again as it does not seem to reflect what is going on in this country?

  5. anon,

    I think there is a bit of a disconnect between Wall Street and the actual economy.

    The one thing you can say is that there is certainly heaps of optimism out there even with the obvious risk factors posed by the housing/consumer decline and energy /gas costs.

    The DOW is a spectacle but the truth is it's only up 14% compared to January 2000.

    That said, I think Wall Street is underestimating the the threat posed by a potential consumer lead recession though.

    It's possible that the next recession will run longer and be more widely felt than the previous two recessions (90s, 2001 dot com bust) which were short and generally contained to certain specific sectors.

    I think it's safe to say that If the worst case scenario happens with housing (which so far seems to be occurring) the worst case for the consumer will like follow.

    We could be in a for a rough ride but only time will tell.

  6. thanks from germany


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  9. As the theory goes, as home values increase, homeowners “feel” wealthier, either directly through home equity withdrawal or indirectly by simply observing the increased value of their home asset.

    The value increases for every home owner that means that if you are looking to buy a bigger house and if the home value is on the up then even though you feel a bit wealthier, you wouldn't feel the same when you go out looking to buy a bigger home that's also enjoying a high value. That also effects the home buyers/owners and can also force them to hold back on spending money around. IMO, it all balances out regardless the property is on the high or on the low.

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  10. honolulu renter11:36 PM

    Don't forget the contracting supply of home equity cashouts. When prices started dropping, and subprime went down, a significant source of refinancing credit dried up for homeowners.

    MasterCard's high earnings this quarter are very telling, IMO.

  11. Hello - I think is a fascinating experiment you are undertaking. Are there are other homes in this area that are for sale at firesale prices?