How does the housing market affect the stock market?

I think the housing market can come into play in various ways. Three things come into mind.

First, the degree of housing price levels can certainly have a bearing on the level of interest rates. For many developed countries where the property sector make up a broader portion of the economy, say more than 5%, central bankers will monitor the level of the prices, lending activities in the mortgage sector, and so on. If they think the property sector looks frothy, then they will preemptively tighten their monetary tools in order to avoid a boom-bust cycle from emerging. Of course, this is not the case what is happening in the U.S. at the moment. Anyway, once the central bank taps the break and increases the rates, ceteris paribus, in general, the stock market will go down because it will slow down the real economy and hurt the profits of many firms.

The second way of looking at this is, the commercial banks can curtail their lending volumes to businesses once they realize the loans given out to the real estate sector looks less creditworthy. This in turn will crowd out financings that can be disbursed to the needed companies, and thus hamper growth projects that have potentials to lift the stock price.

The last case is when mortgage related loans are securitized, and the broad investment community invested heavily on these products. This was the case in the U.S. subprime, and many investment firms had to unload their non-mortgage related investments just to have cash in their hand.