January 12, 2005

By Matthew Lynn

The long-predicted slowdown in Britain's fevered property market finally seems to be happening. What will that mean for stock prices?

Will the property market bring down equities with it? Or have the two markets decoupled, allowing shares to soar in value as property slumps?

The record suggests equities can escape unscathed. Yet common sense tells us there may be some nasty shocks ahead for people who own British shares. It isn't just in the UK that property prices have surged.

They've been rising in the US, France, Spain and Australia.

All of those nations may witness a sharp correction in property prices and will be watching the UK to see how it responds to a reversal in house prices.

Nobody can doubt that the British property boom is ending.

Figures released last week showed UK net mortgage lending in November rose at the slowest pace since June 2002, while home loan approvals slumped to the lowest in almost a decade.

HBOS, the country's top mortgage lender, said house prices rebounded slightly in December. Yet it added that prices would probably fall 2 percent in 2005.

Will it be a soft or hard landing?

Since the UK property market has cooled faster than most people predicted, there isn't much reason to be optimistic.

"The sharp dropoff in housing market activity over the second half of last year suggests that the falls in house prices seen over recent months are likely to persist for some time to come," Ed Stansfield, property economist at London-based Capital Economics, said last week.

"Our forecast of a 20 percent peak-to-trough fall in average house prices over the next two to three years remains on track."

What are the implications for equity markets?

History is surprisingly reassuring. HSBC Holdings says "equity and house price indices are essentially uncorrelated in the UK".

Why is that?

"The overseas exposure of the UK equity market, the fact that it is defensive in nature, and that equities are a competing asset class to property, all seem to offer support to the equity market during a domestic shock."

Indeed, from 1989 to the beginning of 1993, as the UK property market slumped, the benchmark FTSE-100 index jumped from about 1800 points to about 2800. That suggests the next three years would be good for shares.

Others draw comfort from international experience. In a comparison between the Australian and UK property markets, Brian Hilliard, chief economist at Societe Generale, says a fevered Australian housing market has started to cool, with little damage to the rest of the economy.

"This provides support for our view that the UK economy will be able to withstand the downturn in the housing market, currently in progress, with a fair degree of resilience," he wrote in a report last month.

The British economy has become heavily dependent on the property market as an engine of growth. That's because soaring house prices make people feel richer, so they spend more.

A housing slump would suck that demand out of the economy, hurting the stock market. Next, financial services have grown in importance in the economy.

Banking accounted for just 5.3 percent of the UK market at the previous peak in the property cycle in 1988, according to HSBC.

That compares with almost 20 percent now.

Of the 10 biggest companies in the FTSE-100 index, five are banks. Those banks may not be stuck with many bad loans as the property market declines - most lending has been relatively conservative. Yet as mortgage sales slow, banks will be hurt.

And consumers may well be reluctant to take out fresh loans as the value of their houses crumbles.

History might suggest the equity market will survive the property slump unscathed. So might international comparisons.

Don't be fooled. The UK stock market is about to enter territory for which there are no maps. It will be different this time around.


Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own