This week Brickowner takes a comparative historical look at UK Housing Markets and the FTSE, and if past trends in both indices might give us some insight into today’s market?
Any investment portfolio should be diversified to balance risk and returns. However, the question still remains: how to balance the portfolio? Different asset classes have different characteristics (which is why they can be uncorrelated); they have different strengths and weaknesses, so it’s important to choose the right balance of strengths and weaknesses across a whole portfolio. To this end, it’s useful to be able to compare investments.
The asset class we focus on at Brickowner is property, but in the UK, the FTSE 100 is generally used as a day-to-day barometer of the economy. So how do the two types of investment compare? To examine this we’ve put our analysts to work to look at the House Price Index and FTSE 100 index, from 1985 to 2019.
Caveats and Considerations
There a few caveats to the following analysis. Firstly, both indices are averages. This means that when an index is falling, there are many individual assets within the average that are rising. Similarly, when an index rises, many assets depreciate. The individual details of the assets are of paramount importance when choosing an investment (See: Brickowner’s previous blog, Common Sense Property Investment).
Secondly, past performance is not a good indicator of future performance. You would not drive a car by looking in the rear-view mirror, so you should not invest based on historical data. Nevertheless, we can always learn from history, and use it to build understanding of the present.
A final note: the HPI was only reported quarterly before 2002. Therefore, in order to simplify the analysis and fairly compare the two, we have only used quarterly data for both indices (except in the chart, where all available data is used).
With that in mind, let’s look at the performances of both indices from 1985 to 2019:
From an unscientific first glance at the chart, we can see a few interesting points. The 1987 crash (“Black Monday”) is visible as a sharp drop in the FTSE. The “Dotcom Bubble”, with its boom and bust, is visible between 1995 and 2002. And the Global Financial Crisis of 2008 is an extremely sharp and large drop in the FTSE, bottoming out early in 2009. With respect to the House Price Index, there is considerably less to see: the 2008 crash is visible, but the drop is much shallower and smaller than that of the FTSE. Aside from that, the index has risen steadily since the mid-90s. It was not impacted much by Black Monday or the Dotcom Bubble, and generally does not experience the same number of visible drops that the FTSE does.
Statistical analysis bears this judgement out. Interestingly, the coefficient of variation (a statistical measure of dispersion) is higher for the HPI than the FTSE over the period (0.54 compared to 0.40). But this is because the coefficient of variation is not only measuring volatility; it is also measuring the overall increase over the period. The HPI has risen much more: the highest value of the HPI is 7.4 times larger than the lowest, whereas the FTSE’s peak is only 5.1 times its lowest value.
To get an idea of volatility, we can look at the quarter-on-quarter changes in index values. The coefficient of variation for the changes in HPI is much lower than for the FTSE: 2.2 compared to 9.9. This means that, quarter-on-quarter, the HPI tends to change much less than the FTSE. In other words, it is less volatile.
Another interesting comparison to make is the drops in both indices. We have already mentioned the sharp declines in the FTSE with Black Monday, the Dotcom Bubble, and the Global Financial Crisis, compared with the apparently less drastic declines in the HPI. This observation, too, holds in statistical analysis. The total value of declines across the period was 24 points in the HPI and 9,734 points in the FTSE.
In comparable terms: the HPI fell a total of 38% of its average across the period, whereas the FTSE fell 208% of its average. This difference is stark. It suggests that the FTSE was much more likely to fall by substantial amounts.
If we just look at the Global Financial Crisis, which originated in housing markets, we see a surprising fact: the HPI was less volatile over the period than the FTSE. This is seen unscientifically in the below graph, where we see a deeper trough for the FTSE:
Being more scientific, we find that the HPI fell 19% over this period, whereas the FTSE fell a whopping 43%. The HPI did not respond to the shock as much as the FTSE, even though the shock was rooted in housing markets.
In summary: from 1985 to 2019, the FTSE 100 index grew by proportionally less than the House Price Index. The FTSE was more volatile quarter-on-quarter than the HPI. And the FTSE declined far more than the HPI. Even the Global Financial Crisis, which originated in housing markets, affected the FTSE more than the HPI.
This is far from an exhaustive comparison. We have only looked at two indices; markets are complex beasts, and individual investments always have their specific characteristics separate from the behaviour of the overall markets. And, as always, past performance is not a reliable indicator of future results. Hopefully, however, the above analysis will provide some interesting insights into the historical characteristics of two indices.