When it comes to the health of the economy – whether it’s the American economy or the global economy – people often look at the stock market and real estate as two foundational aspects. But when you really drill down and look at the technical factors involved, are these two elements of the economy directly driving one another?
What relationship exists?
Depending on who you ask, there’s either a very strong relationship between the stock market and real estate prices or very little connection at all. It’s a highly divisive topic that requires a deeper dive. However, we’ll attempt to cover some of the basics and a couple of different opinions on the topic.
One school of thought says that, of course, the two are related. After all, there’s typically stock appreciation and real estate appreciation in a healthy economy, while there’s declines in both markets during a receding economy. We’ve seen this very clearly over the last 15 years as the housing market collapse and stock market collapse occurred in harmony, followed by a decade of growth in each sector. But to say that one directly affects the other in a predictable manner wouldn’t be entirely accurate.
For proof of this, consider the period between 1968 and 2011. While both home prices and stock prices increased, the ebbs and flows weren’t mirror images of one another.
“Eyeballing the line graph for this period indicates no systematic relationship between home prices and stock market levels," financial advisor William Pirraglia wrote in a research not for Zacka Investment Research. "Even plotting just annual prices and changes, you'll see no direct visual evidence to help you make intelligent assumptions about a correlation, either positive or negative. The only conclusion you can make is that both home and stock market prices did increase over four decades.”
There’s clearly a relationship between the strength of the U.S. and global economies on both stock and home prices, but this isn’t unique to these two classes. During a healthy, growing economy, there’s increased spending in almost every product category. Whether it’s cars, furniture, appliances, homes or stocks, demand is up. In other words, this is a general relationship – not something that’s specific between stocks and real estate.
This isn’t to say, however, the real estate market never directly impacts the stock market, or vice versa. We’ve seen plenty of isolated instances in which it does.
“In general, economists content themselves with establishing a correlation – that a rise in one market correlates with a rise in the other," Patrick Gleeson wrote in an article for PocketSense. "The exception is the subprime real estate market meltdown in 2007. Most economists agree that a bursting U.S. real estate bubble directly triggered a collapse of the stock market.”
The important thing to remember is that causation and correlation are totally different concepts. Just because the stock market and real estate market tend to be closely correlated, doesn’t mean one causes the other.
It’s also important to take mortgage rates into consideration. Real estate prices are at all-time highs in almost every developed country at the moment. We know about the U.S. market, but values are up across the board – including in Australia, where interest rates make buying a home more affordable than ever. As interest rates increase, it’ll be interesting to see how these adjustments impact other elements of the economy.
Historically, the stock market tends to take a little bit of a hit when interest rates rise. Lower interest rates cause more people to purchase homes. When people are purchasing homes and seeing values rise, they feel good about the economy and have the confidence to invest in the stock market. But when interest rates inch higher, home price appreciation slows, confidence wanes and people are less inclined to throw money into what they see as an “uncertain” stock market.
While this is all speculative thinking, it just goes to show how people assume real estate and the stock market are tied together. In reality, it’s more that interest rates and the stock market are in a shared relationship.
How this relationship should impact your investing
If there’s one thing we know to be true, it’s this: both real estate values and the stock market appreciate over time. While each may experience declines in a three- or five-year period, they’re always going to increase over a 10-, 15- or 25-year chunk of time. And assuming that you’re dollar-cost-averaging, you’re always going to come out on top.
Read more here:
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- Pass Your Portfolio Forward: 3 Estate Planning Tips
- Why Is Apple Always Undervalued?
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