May

14

 A striking feature of recent stock market moves is the weakness of the housing sector. For example, the S&P 400 Homebuilding Index, which is a cap-weighted index with six members (NVR, Toll Brothers, Ryland, MDC, Beazer and Hovnanian), with a base of 100 as of year end 1990, hit a high of 725 in July 2005, and now stands at 373, down from 450 as of three months ago.

Needless to say, this decline has been heralded as indicative of coming woes in the overall stock market. But as with most things widely disseminated by the media, shouted from their posts in Trinity Church by chronic bears (where they wait to hook a lunch from a member who's not broke from listening to them), such views are false and lead to the public's losing much more money then they have to.

Practical Speculation has a chapter on the relation between real estate prices and stock prices, following in the footsteps of Henry George. Studies show that boom/bust cycles in the economy and stocks are started when real estate prices get out of line with underlying economic activity. When real estate is too high, retailers can't make a profit and they downsize. When real estate falls, retailers and others who use property make more profit because their costs of real estate is lower. Henry George and others, such as Homer Hoyt, documented this phenomenon for many economic cycles up to the 1930s. David Ricardo first elucidated the theory.

Laurel and I documented that the cycles had continued vis a vis REIT prices, with declines in quarterly REIT prices forecasting gains in the overall market in the next quarter of about twice the normal rate, 7% versus the normal 3%. We recently updated the study to look at what happens to the overall market after changes in the S&P 400 Homebuilding index and found a highly negative predictive correlation of -20%. After quarterly declines in the Homebuilding index, such as we've just witnessed, the average gain in stock prices in the next quarter is 5%, with about a 75% chance of a rise. Once again, a commonly held fallacy leading the pubic to sell when they should buy bites the dust.

Kim Zussman writes: 

Here is a quick check of HMI this month change vs next month change in SP500 index (12/85-3/07):

Pearson correlation of HMI chg and nxt mo rt = -0.085
P-Value = 0.167

Regression Analysis: nxt mo rt versus HMI chg

The regression equation is nxt mo rt = 0.00889 - 0.0535 HMI chg

Predictor      Coef       SE Coef        T        P
Constant    0.00889    0.00260     3.42   0.001
HMI chg    -0.05353    0.03859   -1.39   0.167

S = 0.0424313   R-Sq = 0.7%   R-Sq(adj) = 0.3%

Negatively correlated, but not quite significant, on monthly frequency.

James Tar remarks:

Shorting real estate and housing is difficult. You can't go out in the housing market and get a borrow on a few million homes that you can then go out and short. So everyone in the market who wants to be short housing/real estate is crowded into the homebuilders and select REIT issues. REITs have high dividends, so you can imagine how expensive it to carry your bearish disposition. A few buddies of mine running fairly large funds are feeling the pinch.

A good way to make sense of it all is to step back and take a look at what is really going on. I believe inflation, just like alpha in the stock market, is a finite quantity. There is only so much inflation that can go around. My studies indicate that the deflation we are seeing in housing/select REITs/mortgage banks is just about the same amount in dollar terms as the inflation we are seeing in energy, precious metals and agriculturals. So there is an inflation/deflation cycle constantly at work in the marketplace. As some assets inflate, others deflate.

To make sense of a confusing cycle, look for smaller, more easily identifiable components within this difficult game. I am looking at firms such as Georgia Gulf Corporation. Till the middle of last week the market believed it was headed for Chapter 11. But now this key supplier to the housing market has a much different story unfolding, perhaps indicating the imbalances in the housing market are declining.

From Alan Millhone:

On a very local note, I was talking to a neighbor the other night who was chatting with a man we both know who wants to build a new home. My neighbor said the fellow had scheduled several appointments to meet several builders and none of them ever showed. He asked me if I wanted to meet with this person and I told him no.

Houses are hard to figure due to rising material costs and the volatile changes in prices, sometimes on a daily basis. Also, I am now figuring mileage for my employees into my jobs X-number of days I project we will be on a particular job. I am confident giant home builders are having a tough time getting a firm handle on material prices to 'lock in' their hard costs of building homes in vast subdivisions. At present I would want little to do with building stocks of any type. 

Roger Arnold writes:

The real estate pros who stepped out in 2005 are prepping to get back in and with big ideas about restructuring the entire industry. Gargantuan funds are prepping to get into the real estate game.


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