Judging by the mood of the market, buying real estate stocks would have to be up there with the most dumbest of things to do! Yet seemingly against all odds the real estate sector, in its various shapes and forms, is one of the star performers of the stock market this year. What is driving this behaviour? I guess the media of popular opinion will inform us over the weeks to come as to the “real” reasons. Our suspicions are that the price performance is more to do with inflationary fears than anything else. In times of high inflation you don’t want to have money lying around in the bank, rather you want it to be invested in hard assets (things that hurt when dropped on your foot) and yes, that includes “bricks and mortar” as well.

Just how strong is the real estate sector? We believe that the behaviour of small cap stocks gives a true representation of the behaviour of a market or sector. We find that problems with markets often show up first in small caps before large caps. Anyway the graph below of the S&P 600 REIT sector suggests that the strong showing in the big real estate ETFs such as IYR is not just a reflection of the behaviour of a few large caps rather it is a broad based phenomenon.

The elasticity of housing supply is the effect on the flow of home building (measured as a log change -- think of it as a percentage change) of the inflation-adjusted purchase price of housing (also measured as a log change).

The elasticity has long been studied in economics; one of the seminal studies was published by Professors Topel and Rosen in 1988.

Last week I posted a Bloomberg news article supporting my suspicions that investors are putting bad loans back to the banks at an increasing rate. I used JP Morgan (JPM) as a specific example - Banks Swallow Another $30 billion or So in More Losses as Their Share Prices Surge (Again).

A few commenters on syndicated sites appeared to have really underestimated the significance of this development. In the article, it is alleged that Freddie (FRE) and Fannie (FNM) are forcing banks to eat up to $30 billion in soured mortgages under the warranties and representations clauses of the sales contract. To highlight the significance of this development, let me remind all that Fannie and Freddie are benchmarks for mortgage lending in the US.