Is the Housing Bubble Popping?

Friday was a bad day for housing stocks and this could be a sign that the housing bubble may have sprung its first leak. This is what the Philadelphia Housing Index looked this week – losing about 5% for the week.

Investors have made around 50% on their money since I first reported on the housing bubble and there could very well be more bubbling to come. Here is a linear graph of high-flying Toll Brothers (TOL), one of the largest homebuilding companies. The stock has increased by over 50% in the last year. Optimists point to the company’s price-to-earnings ratio of "only" 15, which is below the market average.

The pessimist case for a bursting or deflating of the housing bubble is the issue of rising interest rates. As Greenspan increases short-term interest rates it causes problems for those who have variable rate mortgages tied to short-term interest rates. Energy prices and a slowdown in the economy can also dampen enthusiasm in the housing sector.

The larger problem may be for long-term rates. As Greenspan increases short-term rates the thinking goes that he is reducing inflation expectations and thus reducing the likelihood of increases in long-term rates. However, if long-term rates rise, this is an indication that short-term rates are not rising fast enough to dampen inflationary price pressures. The graph below shows a big increase in the interest rate on 10-year Treasury bonds on Friday that coincided with the fall in homebuilder stocks.

Here is a graph of the interest rate on 10-year Treasure bonds over the last six months. The interest rate made a "double bottom" this summer – below 4% – the lowest rate ever in my lifetime.

A double bottom is a term from technical analysis which is a bullish indicator, which in this case argues for much higher long-term interest rates. Higher rates spell trouble for the home builders and give some indication the housing bubble might be coming to an end.

Hopefully, Alan Greenspan will know the correct lever to pull next. He did in the 1960s.