Stocks to Real Estate Ratio
The Stocks to Real Estate ratio divides the S&P 500 index by the Case-Shiller Home Price Index. Just like Market Cap to GDP, the Stocks to Real Estate ratio has an interesting historical track record and clearly shows the stock market bubbles of 1929 and 1999.
The Case-Shiller Home Price Index seeks to measure the price of all existing single-family housing stock. Based on the pioneering research of Karl E. Case and Robert J. Shiller the index is generally considered the leading measure of US residential real estate prices.
This chart plots both the S&P 500 and the Case-Shiller Home Price Index. Over the long term the S&P 500 clearly outperforms residential property and is more volatile. The housing bubble and subsequent stock market crash are clearly visible in the chart.
The chart above displays the 1-year rolling correlation coefficient between the S&P 500 and the Case-Shiller Home Price Index. A correlation coefficient of +1 indicates a perfect positive correlation, meaning that the two indices moved in the same direction during the specified time window. Conversely, a correlation coefficient of -1 indicates that they moved in opposite directions. The chart shows that the correlation between equities and home prices is not stable and can vary, even during economic recessions. The correlation coefficient is important for diversification because it helps investors assess the potential benefits of including both equities and real estate in their investment portfolios.
Diversification is the practice of spreading investments across different assets to reduce risk. In his book Principles, Ray Dalio called diversification the “Holy Grail of Investing”. He realized that with fifteen to twenty uncorrelated return streams, he could dramatically reduce the risks without reducing the expected returns.
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