Understanding the value of something is always a relationship thing. Picking the right relationship is the key to understanding the opportunities/risks provided by a divergence between price and value. Another thing to recognize is that like social relationships financial relationships can get seriously irrational on either the upside or downside.
One of my favorite relationships is house price values relative to median income. Houses when viewed in an ecological framework are physically constrained to a given catchment area. The resources that keep them strong (value wise) are the available incomes in that catchment area.
Rental income to home price ratios are just a sloppy proxy for this relationship. House value isn't a function of replacement value etc. Detroit with its average home price of <$10,000 should make this point. The relationship is between median incomes in an area and the price of the available homes.
This ratio has historically been about 3:1 in the US. Here is a video showing the US relationship over time. The ratio was temporarily distorted by the magic of securitization, govt programs etc. but has now resorted back to its original relationship of 3:1. Beware of unquestionable financial beliefs. The chart below came from a very useful blog called Sober Look who lifted if from Credit Suisse, who lifted it from DataStream.
The bad news is that median income recently reported a 3.3% decline albeit looking backwards. If this level were sustained it would indicate a further 10% decline in house values fair value.
Another important factor to consider is that the median figure hides a likely increase in the variance of incomes and regions. This affect the economic and value impacts on 2 axis.
The likelihood of extreme pockets being created with continuing downward spirals such as Detroit on the geographic data axis. On the time axis the potential for the mean or median to hold over time at 3:1 would statistically indicate potential for overshoot on the downside. In the long run things will stabilize, but a 7 year debt/asset bubble is rarely rectified in a few quarters.
The process known as the great depression had a false dawn about 2 years after the equity market decline.
Given the consumer debt load and new found interest in a saving behavior a net contraction of 12-17% in US GDP would not be surprising to me over the next 3-5 years.
The potential for, consumer consumption declines or falling to normal (sans housing wealth effect) followed by more fiscal stimulus at the federal level still leads me to speculate we are in a dollar/ US debt bubble of significant size.
The recent California bond auction is not a dead canary in the coal mine, but certainly a bird with labored breathing.
The ever shortening US govt. duration (about 4 years now) is worrying. A debt maturity which needs be to rolled over at a faster pace will one day lead to ever increasing auctions. One of those auctions will be an egg, maybe not a latvian sized egg, but an egg none the less and that failed auction will be yet another prick in yet another financial bubble. que sera sera.