Tony Crescenzi
Senior VP,
Strategist,
Portfolio Manager
Pimco

If there’s one indicator that investors are likely to embrace as their yardstick for the housing market predicament it is the Case-Shiller home price index. This is the index that turned lower in 2006, presaging the eruption of the credit crisis. Its apparent stabilization hence marks a turn in the housing dilemma.

Although a plethora of data have pointed to stabilization in housing of late, only the Case-Shiller index has the power to sway doubters, chiefly because it captures trends in the subprime mortgage market better than other indicators.

Few were convinced, for example, by the recent stabilization in the Federal Housing and Finance Agency’s home price index, which gained 0.1% in the first five months of this year, posting gains three times, including a 0.9% gain in May. The FHFA’s index hadn’t the power to sway doubters because it captures price trends in mortgages backed by Fannie Mae and Freddie Mac. Case-Shiller’s index, on the other hand, by looking beyond the conventional space and focusing on regions plagued most by the housing dilemma, has been the main focal point for investors.

We will learn in the time ahead whether investors took seriously any of the many clues about the housing market’s stabilization, or if the Case-Shiller index will be the gauge that convinces.

The current mindset of investors is to think cyclical, not secular, which means that the Case-Shiller index will reinforce current trends, giving new wind to the sails of risk assets, at least until the many constraints to growth constrain their performance.

What is it that may be stabilizing home prices?

The answer lies in simple economics.

The fact is, the supply of unsold homes has begun to shrink because housing construction has plummeted relative to household formation. Specifically, housing starts of 582k (June) yield about 400k new units (about 200k—historically more—of the tally represents teardowns and other forms of replacement), which is well below household formation, which tends to average about 1.2 million per year.

In a recession, household formation shrinks a bit, with the number of people per household increasing. Still, even when adjusting for this, the nation is still under-building relative to its growing population. Those that counter this idea by saying that the home ownership rate is falling should keep in mind the fact that people are born short a roof over their heads and that they will cover somehow, either by buying or renting. As for the supply tally, take note of the drop in unsold new homes, which at 281k is at its lowest since February 1998 and 100k below the average since then. The stock of existing homes is still problematic, of course, at 3.82 million, or about 1.3 million above normal.

Still, the tally is 800k below the peak and is trending down.

Keep in mind also that demographics are favorable for maintaining a healthy level of household formation. Birth statistics show that the age group 25-34 will grow at a relatively strong pace over the next 10 years. This is important because this age group represents about 25% of all new home buyers, compared to just 2% for the 20-24 age bracket. A key variable is immigration.

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Tony Crescenzi is Senior VP, Strategist, Portfolio Manager Pimco. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."