Case Shiller Index Revisited

Recently I read a story in Crain’s Chicago Business titled "Local Home Prices Up for 5th Month". The story reported, "an index of local home prices rose for the fifth straight month in September, further evidence that the housing market recovery is continuing. The Standard & Poor’s/Case-Shiller home price index for the Chicago area increased 1.1 percent from August on a seasonally adjusted basis. Local prices were still 10.6 percent below their level in September 2008, according to a report released Tuesday by Standard & Poor’s."

In early 2008, I projected that the Case Shiller index for Chicago would require a 14% drop (about 22 points) off its peak of 162 to return to its long term trajectory. The total drop from the peak has been about 25% (about 40 points), so it makes sense that the index has reversed course. The drop below the trend line is approximately equal to the magnitude of the increase of the index above the trend line - 20 +/- points.

The question now is how steep will the slope of the index be as is moves back to equilibrium. The index was above the trend line for nearly 8 years from 2000 to 2008. Will the return to equilibrium take half that long?

At its current trajectory and slope, the index would intersect the long term trend line by about mid-2010. However, I would expect the slope of the index to decrease and flatten out in the coming months, which would put the point of intersection out to sometime in 2011. Experts warn against concluding that this reversal in the index is a clear sign that the housing market has bottomed. We may experience another dip in the market as foreclosures continue to increase. However, I expect this will merely flatten out the index rather than reverse its direction.