Tuesday, November 5, 2013

Real Estate / Housing - Ominous Divergence!!

Housing industry is the mainstay of the U.S. economy. Without robust housing recovery it will be difficult to sustain a robust economic growth in the U.S. Housing industry fuels a lot of jobs and allows financials to rally. Financial stocks are heavily dependent on the housing sector because loans made out to home-buyers yield significant profits. Moreover, credit rotation in the U.S. economy is primarily governed by the housing and real estate sectors.

Therefore, whenever the housing and/or real estate sector starts to under perform, astute investors take notice. We are in one of these times, where housing and real estate ETFs like ITB and IYR are lagging the market. This can be a dangerous sign for the overall economy.

At Understand, Survive and Thrive, housing sector's warning signs were documented in great detail in August 2013. Following articles were published in this regard to warn about potential housing risk, and to not get overly bullish about investing in this sector:

  1. Is Housing About to Take a U-Turn: Road to Recovery to ...
  2. Housing Market - Near Term Picture
  3. Housing Market - Down Trend Resumption
  4. Real Estate Market - End of Recovery?
  5. 2009-2013: Real Estate and Housing Rally Analysis

Since then SP500 and DJIA managed to make new highs (as predicted by the daily IPM model in late August). But housing and real estate sectors have been diverging from the broader U.S. indices since May. This is a dangerous sign for the broader U.S. stock market.

Housing ETF - ITB 
Real Estate ETF - IYR

A similar divergence was seen before the 2007 stock market peak. At that time, housing sector started lagging the broader indices since early 2007. Finally this divergence caught up to the broader stock market, and SP500 / DJIA topped in October 2007. This top was followed by nearly 50% plunge in stock prices. Following charts show the divergence as seen in 2007.

There are several reasons why this divergence should be taken seriously:
  1. Housing sector is a very economically sensitive area. It foretells upcoming credit conditions, buying power of the consumers and consumer confidence in the economy. If it starts lagging behind, it typically means that the economic under-currents are not very strong i.e. consumer demand and buying power is waning. Since consumers derive U.S. economy, dwindling consumers is a bad omen for the overall economic growth
  2. Housing sector's growth trickles into numerous industries. And therefore, a slowing housing industry could be a bad sign for several peripheral industries.
One very interesting aspect of the 2013 ITB (Housing ETF) and IYR (Real Estate ETF) is that both of these sectors topped exactly during the weekly IPM Top date. This date was emailed to subscribers in May. Since topping in May, these sectors have only managed to make lower highs so far. Moreover, another weekly IPM Model Turn window is approaching (dates emailed to subscribers). So the big question is: Is this sector going to make a lower high during the upcoming Weekly IPM Turn window. A lower high in a turn window, typically foreshadows a Bear market!!

Although these divergences can resolve themselves with a sharp rally in the housing stocks, we need to keep these in mind till the time they are not resolved. However, trading decision should not be purely based on a potential divergences because a divergence does not typically materializes till the broader stock market index follows to the downside. Therefore, trading decision should be based on your own methodology, along with other indicators like IPM Model turn windows. In the next update, we will evaluate this divergence in relationship with the broader U.S. market to analyze the possibility of SP500 making a new high even with this ominous divergence. 

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1 comment:

  1. it`s different this time. in 2007 bush pushed up interestrates to 5 % which was very negative to homebuilding. now all this free Money should lift homebuilding again.


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