These figures show that mortgage approvals for house-buying have hit a 19-month high. Cue talk of a stronger housing market.
What the experts won't tell you is that rising mortgage approvals are also a leading indicator of share prices. Since 1990, the correlation between the level of mortgage approvals and annual returns on the All-share in the following 12 months has been a statistically significant -0.34; the R-squared is 11.4%. This link holds even controlling for the predictive power of the dividend yield. And it points to zero returns in the next 12 months.
There's a simple reason for this. High mortgage approvals mean people are sufficiently risk-tolerant to want more debt. There's a correlation between this appetite for risk and appetite for equity risk. And low risk aversion means low returns.
This doesn't mean you should rush out to sell. The relationship, though statistically significant is economically weak. And another leading indicators of returns - financial institutions' cash holdings - are booming, which points to good returns.
Instead, there are two messages here.
1. Mortgage approvals don't matter merely for house prices. It's a
plain cognitive error - the representativeness heuristic - to think otherwise.
2. There is (limited) predictability in share prices. For me, the interest in financial markets lies in uncovering this predictability, rather than listening to the prattle that passes for the judgment of experts.
Comments