Data through September 2012, released today by S&P Dow Jones Indices for its S&P/Case-Shiller[1] Home Price Indices, the leading measure of U.S. home prices, showed that home prices continued to rise in the third quarter of 2012.  The national composite was up 3.6% in the third quarter of 2012 versus the third quarter of 2011, and was up 2.2% versus the second quarter of 2012. In September 2012, the 10- and 20-City Composites showed annual returns of +2.1% and +3.0%. Average home prices in the 10- and 20-City Composites were each up by 0.3% in September versus August 2012. Seventeen of the 20 MSAs and both Composites posted better annual returns in September versus August 2012; Detroit and Washington D.C. recorded a slight deceleration in their annual rates, and New York saw no change.

The S&P/Case-Shiller U.S. National Home Price Index, which covers all nine U.S. census divisions, recorded a 3.6% gain in the third quarter of 2012 over the third quarter of 2011. In September 2012, the 10- and 20-City Composites posted annual increases of 2.1% and 3.0%, respectively.

"Home prices rose in the third quarter, marking the sixth consecutive month of increasing prices," says David M. Blitzer, Chairman of the Index Committee at S&P Dow Jones Indices. "In September's report all three headline composites and 17 of the 20 cities gained over their levels of a year ago. Month-over-month, 13 cities and both Composites posted positive monthly gains.

"The National Composite increased by 3.6% from the same quarter in 2011 and by 2.2% from the second quarter of 2012. The 10- and 20-City Composites have posted positive annual returns for four consecutive months with a +2.1% and +3.0% annual change in September, respectively. Month-over-month, both Composites have recorded increases for six consecutive months, with the most recent monthly gain being +0.3% for each Composite.

"We are entering the seasonally weak part of the year.  The headline figures, which are not seasonally adjusted, showed five cities with lower prices in September versus only one in August; in the seasonally adjusted data the pattern was reversed: one city fell in September versus two in August. Despite the seasons, housing continues to improve.

"Phoenix continues to lead the recovery with a +20.4% annual growth rate. Atlanta has finally reversed 26 months of annual declines with a +0.1% annual rate as observed in September's housing data. At the other end of the spectrum, Chicago and New York were the only two cities to post annual declines of 1.5% and 2.3% respectively and were also down 0.6% and 0.1% month-over-month.

"Thirteen of the 20 cities recorded positive monthly returns; Boston, Charlotte, Chicago, Cleveland and New York saw modest drops in home prices in September as compared to August; Tampa and Washington D.C.were flat. With six months of consistently rising home prices, it is safe to say that we are now in the midst of a recovery in the housing market."

As of the third quarter of 2012, average home prices across the United States are back at their mid-2003 levels.  At the end of the third quarter of 2012, the National Index was up 2.2% over the second quarter of 2012 and 3.6% above the third quarter of 2011.

As of September 2012, average home prices across the United States for the 10-City and 20-City Composites are back to their autumn 2003 levels. Measured from their June/July 2006 peaks, the decline for both Composites is approximately 29% through September 2012. For both Composites, the September 2012 levels are approximately 9% above their recent lows seen in March 2012.

In September 2012, 13 MSAs and both Composites posted positive monthly gains. Home prices in Tampa and Washington DC saw no change from August to September. Boston, Charlotte, Chicago, Cleveland andNew York saw a slight drop in prices in September. Phoenix recorded the highest increase in annual rate, up 20.4% from its September 2011 level. Chicago and New York were the only two cities that fared worse year-over-year with respective annual rates of -1.5% and -2.3%.

Atlanta, Detroit and Las Vegas remain the only three cities with average home prices below their January 2000 levels.  Detroit with a 79.82 print, is nearly 20% below its January 2000 level.

With an estimated 13 million homeowners underwater on their mortgages and average home prices nearly 30% below their 2006 peak – a decline that has wiped out $7 trillion in household wealth – it is no wonder that many are still skeptical about a housing market recovery.   However, there is reason for optimism, echoed by famed investor Warren Buffett, who remarked earlier this year that he would purchase "a couple hundred thousand" single family homes if it was practical to do so considering depressed real estate prices and the availability of financing at historically low levels.  Against this backdrop, recent trends in the housing market not only bode well for homebuilders, but for certain retailers and the broader economy as well, according to Ken Schapiro of Condor Capital Management.

After a precipitous decline following the housing bubble's burst, home prices have seen a slow but steady improvement so far this year.  To illustrate, the S&P/Case-Shiller Home Price Index posted its sixth straight monthly gain in September, rising 0.29%, extending the year-to-date increase to 7.04%.  Unlike the temporary gains seen in the wake of the first time home buyer's tax credit, this year's recovery appears to be organic and self-sustaining.  The average selling price for existing homes has shown even stronger gains, up 11.1% year-over-year in October.  This can be partly attributed to a decline in inventory, with the number of previously owned homes on the market declining to 2.14 million in October, the lowest since December 2002.  Further, the current inventory of new homes is at its lowest level since data began being collected in 1963.  Consequently, new home starts have been trending higher this year and surged to an annualized rate of 894,000 in October, the highest level in 4 years.  Although this is a vast improvement over the 478,000 rate witnessed in April 2009, it is a far cry from the estimated 1.2 million that is needed to keep up with population growth and household creation.  Given the dearth of building over the last 4 years, it is likely that new home construction will need to accelerate above the historical average to account for this shortfall.  Given the immense money multiplier effect of the housing industry, this could provide a meaningful lift for economic growth in the coming years.

However, it is important to note that the pace of recovery could be divergent between states.  States such as Nevada and Florida that saw some of the steepest declines are now rebounding as investors have stepped in to purchase large lots of distressed properties.  Conversely, more-litigious states such as New Jersey are likely to have a longer road to recovery.  Since such states require a court review of all foreclosures, distressed properties take much longer to come to market, something that was only amplified by the recent "robo-signing" scandal.  Shadow inventories in New Jersey are comparatively large and may pose a headwind to further price gains since distressed sales are typically executed below a given home's true market value.  On the other hand, the devastation left in the wake of Hurricane Sandy could have a silver lining for the state in that reconstruction efforts will spur spending and boost employment of construction workers, one of the hardest hit groups since the last recession.

Looking forward, there are several tailwinds that bode well for sustained momentum in the national housing industry.  First and foremost, low mortgage rates and depressed real estate prices have led to a dramatic increase in home affordability and have swung price-to-rent ratios solidly in favor of purchasing in most markets.  With the Federal Reserve planning to purchase $40 billion a month in mortgage-backed securities in an effort to boost the economy, mortgage rates are likely to remain low, and could even have further room to the downside.  Additionally, forthcoming rule changes should help relax today's strict lending standards and improve borrowers' access to credit.  Beginning January 1, 2013, banks selling mortgages to Fannie Mae and Freddie Mac cannot be forced to repurchase defaulted loans that have experienced 36 straight months of on-time payment if they were originated after January 1^st.  Aside from these monetary factors, certain social and demographic trends that have had a drag on housing since the recession have shown signs of improvement recently.  Amid steep job losses, financial strain, and a weak job market for recent college graduates, new household formation trended well below the historical average in the past few years.  However, in the twelve months through September 2012, 1.15 million new households were created in the U.S., up sharply from the 650,000 per year created in the prior four years.  Although unemployment remains stubbornly high, slow improvement is likely to continue to buoy household creation and drive a move-out-of-the-basement rally.

Despite regional inconsistencies, it is clear that the national housing picture is improving.  Given this, investors' optimism has already pushed the S&P Homebuilders Index up by over 50% in the past year.  At the same time, home improvement retailers such as Lowe's and Home Depot also stand to benefit from the renovation of foreclosed properties as well as the construction of new homes in the coming years.  Other stores, such as Bed Bath and Beyond, will also likely receive a lift from an increase in household formation as young people move out on their own for the first time and purchase household necessities.

A less obvious winner could be non-housing related retailers, as a gain in home prices and a decline in the number of underwater mortgages helps consumers feel wealthier, more financially stable, and more confident to spend their hard-earned money.  Economists estimate that for every $10,000 increase in household wealth, including the value of one's home, consumers spend an additional $400 on discretionary purchases.  With both home prices and stocks up nicely this year and a favorable calendar – with Thanksgiving falling on the earliest date possible – the upcoming holiday shopping season should prove to be strong.  Since wealthier Americans tend to have greater exposure to the stock market, and therefore have benefited more from this year's rally, higher-end retailers are positioned particularly well.  To that end, a recent study by American Express Publishing and the Harrison Group indicated that Americans in the top 10%, measured by income, intend to increase their holiday gift spending by a staggering 21.9% this year.  At the same time, the survey indicated that the remaining population may spend 11% less.  We feel that this could lead to sales that are divergent between retailers.  While Wal-Mart recently struck a cautious note in its outlook for the holiday shopping season, those at the higher end, such as Nordstrom and Coach, stand to perform better than expected due to the so-called wealth effect.