The Analyst: Safe as houses? Don't you believe it

This week, I am departing from the usual topic of fund reviews to take a look at the housing market, which has major implications for UK investors.

Rising house prices make people feel richer (although I don't think this is at all logical), thus encouraging them to spend more, and thus stimulating economic growth. A falling housing market has the opposite effect – people are less inclined to spend and the economy slows.

For some people, falling house prices are a disaster simply because they have treated their house either as a no-lose investment or as a cash machine from which they can make constant withdrawals. Those people are going to have a huge reality check over the next couple of years.

Making a market forecast on house prices is notoriously difficult – but surely a market that has risen on average by 170 per cent over 10 years (and in many areas in excess of 300 per cent) is ready for some kind of setback. I, personally, don't like the term "crash", because it is extremely emotive and unhelpful.

If we were talking about a similar rise in the stock market, then a setback of 25 per cent would seem quite reasonable. Yet, up until recently, many property commentators had been forecasting a flat market. I am always sceptical when people predict a flat market for any asset class, because in my view that never happens. Markets are either rising or falling.

The graph below illustrates the relationship between mortgage approvals and house prices. Mortgage approvals (which in the case of the chart have been moved forward seven months) show a direct correlation with house prices. This makes sense, since if there are fewer mortgages being approved, it is only natural that the near future will see less demand for housing. I think that the chart speaks for itself; it is clearly suggesting that the price falls will continue.

It will be interesting to see what the buy-to-let investors will do. The few who bought wisely many years ago can probably weather the storm, but I fear that many have jumped on the bandwagon more recently and may not fare so well. Many such investors will say that they are in it for the long term (which they should be), but how will they react when they see capital values falling? We will have to wait and see, but house prices are likely to fall further if a significant number decide to sell up.

The housing market bulls always point to the supply and demand equation. Simply put, the argument goes that there is more demand than supply, so prices must go up. However, this only works if we can borrow the money to buy the house in the first place – if we can't borrow, we can't buy.

Also, when we see house prices falling, wouldn't it be sensible to wait a few months to pick up a house more cheaply? These two factors could cause the supply and demand equation to change dramatically.

Perhaps the most dangerous aspect of this country's property mania is the woolly-headed notion that a property makes the ideal pension. In most cases, trading down will not give you enough money to live on in retirement. I think there is going to be a shock in store for those forsaking a proper pension because they think their property will solve all their problems.

So, what might this all mean for stock markets and investors? Many investors abandoned shares for property, believing it to be a better investment, and those who made the switch early enough made a smart decision. As always, it is the last ones to get on the bandwagon who suffer.

I don't see a falling housing market as being helpful to UK shares. That said, the stock market is likely to bottom out far earlier than the housing market as it can more quickly discount the problems into share prices. To illustrate this, consider that major housebuilding companies have already seen their share prices halve.

Equity markets will continue to be volatile, and the news could get worse before it gets better. Yet investors should realise that falls in the stock market do create opportunities (and they will, eventually, in the housing market too). So, while we are going to have it tough over the next couple of years, I believe that drip-feeding money into stock markets over this timeframe will pay off in the long run. One thing above all else is clear in my mind: UK consumers are going to have to rediscover the lost art of saving.

Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent