Uh oh! Is housing in trouble?

I was reviewing some charts after the close and I came upon this chart. Notwithstanding Thursday's action, which was the result of earnings misses by two homebuilders, what does this chart of the homebuilders ETF (XHB) against the market telling us about market expectations about the housing rebound? On a a relative basis, XHB staged a relative rally from the Eurogeddon lows of 2011, started rolling over in early 2013 and now has violated a relative support level.

Now consider this recent post from Barry Ritholz about private equity seems to have gone overboard on the “rent to flip” in US housing. Mr. Market starting to get nervous about housing, especially if mortgage rates rise any further.


Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. 

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Housing bottoming but recovery still uncertain

Bloomberg recent reported that Homebuilders are buying land after years of inventory cuts. Coupled with a buoyant new home sales report, some investors have concluded that housing has bottomed and is poised to rebound.


Wait for the relative breakout
The chart below shows the S&P 500 Homebuilders Index relative to the S&P 500. Relative to the S&P 500, the Homebuilding group is currently undergoing a basing process but calls for an upturn may be premature. Technically, the group needs to break out of its relative trading before we can definitely call for a recovery.



My gut feel tells me that sentiment isn’t quite washed out for an upturn. We need a magazine cover style capitulation, or for the popular media to really jump on the story. Here is an example from Britain’s housing bust from the 1980s:




Bottoms are a process
This form of relative analysis isn't new. I posted on the bottoming process undergone by the group last August and again in January. I suggest that investors shouldn’t get overly enthusiastic in anticipation of a rebound. We need to watch and wait for the relative breakout before sounding the all-clear.

How to spot THE BOTTOM

Was that the real thing? Is this the new bull?

Just as the consensus was forming that the rally from the lows last week was the start of a bear market rally (example here), the Fed announced that it invented another tool to throw money at the financial system by buying U.S. Treasury bonds at the long end of the yield curve. The announcement sparked off a stock market rally that took the S&P 500 to an interim resistance level of 800.


What now?
What’s more, Merrill Lynch’s institutional survey shows increasing levels of bullishness among fund managers. If they start to put money back into the market, the funds flow could easily raise the S&P 500 by 100 points or more in fairly short order.

Is this the start of a new bull?

This has been a market of maximum frustration for many traders. While the consensus has been that we are witnessing a bear market rally, I would not be surprised that if the market powered itself upward and then fell back but does not test the bottom made last week, as expected by many technicians. Instead it bottoms at 5-10% above those levels, faking everyone out again.


Stealth bottom?
My base case is a “stealth bottom” as called for by Bill Luby at VIX and More and other analysts. Instead of a dramatic high volume capitulation V-shaped bottom, we could very see a bottom marked by an attitude of “I don’t want to hear anymore about stocks”:

[P]ast bottoms were more often than not distinguished by investor disgust, exhaustion and apathy. Having been burned for so long by the bear markets that preceded those bottoms, investors resolved never, ever, to trust the market again. By the time the market did finally bottom, therefore, there were relatively few investors who were even interested enough to take notice.

What to watch for
The fact is, I have no idea of whether we have seen the bottom of the market for this Bear. I tend to agree with Jeremy Grantham that equities look attractive right now. Long-term investors should have a long-term plan, which includes being fully weighted in equities (possibly on a dollar-cost average basis) at current levels. As an investor, you will find it very hard to catch the exact bottom but the likelihood of regret in 3-5 years is low if you bought into stocks in 2009.

For traders who are willing to bear tactical risks and want to spot THE BOTTOM, here is a list of what I am watching for (in addition to Barry Ritholtz’s list):

Sentiment: I would like to see sentiment measures, such as the AAII bull/bear ratio, approach new lows while the market makes a higher low (and forming a positive divergence).

Phoenix list composition: The latest list of Phoenix stocks numbered 58 names. Of the stocks on that list, about 25, or 43%, were in sideways basing formations. I would like to see that percentage of Phoenix stocks in basing mode increase to at least 60% before I could be confident that a bottom is truly in place.

Better market action from the financials: The chart below shows the relative performance of the KBW Banking Index (BKX) and S&P Homebuilder SPDRs against the S&P 500. Since the market is so focused on the troubles experienced by the banks right now, I would like to see some basing action from the banks and financials, much like the formation shown by the homebuilding stocks.

Don’t panic: Real-time data points to stabilization

When I have done fundamental research in the past, I focused on the company’s strategy and its drivers of profitability and growth. When I expand my investment universe to thousands of companies using quantitative techniques, I used multi-factor models based on the usual suspects: value, growth, momentum, sentiment, signals (e.g. insider activity, buybacks, etc.)

When I do top-down analysis, my philosophy differs from many other researchers in the field. During these times when economists bicker about the stimulus package, it’s important to keep in mind that 2009 will be the year when the economic crisis fully migrates from Wall Street to Main Street. The headlines will get a lot worse before it gets better.

Particularly during periods like this, economic statistics are not very useful because they are mainly backward looking. For top-down analysis, I prefer to rely on real-time market signals.


Don’t panic
The real time data is constructive for the economic outlook. The equities of two leading industries that I watch closely, homebuilding and temp agencies, are showing signs of stabilization.

Homebuilders appear to be trying to put in a bottom compared to the market. I also put together a composite of the stock of Staffing and Temp Agencies and compared their performance relative to the S&P 500. As the chart below shows, this group has broken out of a relative downtrend. More importantly, this group doesn’t seem to be totally falling apart despite the dire headlines hitting the mainstream media. The chart indicates that the group has only retreated to a relative support zone dating back from 2003-5.




Bad news already discounted?
Another important sign to watch is how the market reacts to bad news. A case in point, the outlook for Tech earnings looks terrible, but the chart below shows the NASDAQ 100 outperforming the S&P 500. Is most of the bad news in the market already?

It’s so bad it’s good
The psychology is terrible. It is so terrible that the blooger VIX and More is reporting a buy signal from his global volatility index.

We seem to be entering a “bad news is good news” phase for the market. In fact, there are indications that there is an inverse long-term relationship between employment and equity returns.

I believe that as long as we don’t see an ugly surprise like protectionism rear its ugly head, most of the bad news is in the equity market and the downside is limited at current levels.

Some signs of spring for the homebuilders

Remember housing? That’s where this crisis started. I have been waiting for stabilization from the Homebuilders for some time as a sign that this bear market may be at an end.

Now comes an article by Irwin Kellner that housing valuations are becoming more reasonable. Scott Grannis at Calafia Beach Pundit largely agrees and is cautiously optimistic about the housing sector as well. Though these signs do not mean that housing prices don’t overshoot on the downside, it does portend some hope for the Homebuilders.


Listen to the market
Kellner's views are confirmed by the market action of the homebuilders. The chart below shows the relative returns of the Homebuilder SPDRs compared to the S&P 500. The Homebuilders have broken out of a relative downtrend relative to the market and they are now in a basing period. I would expect the group to stay in this trading range some time before breaking out on the upside.




Watch this space for the upside breakout in the next 6-18 months as that could be another indicator the bull is ready for a sustainable run to the upside.

Time to cover housing shorts

I write these words with great trepidation as I hate to agree with Greenspan and his housing call as he has been consistently wrong in his analysis for a long time.

However, I do believe that the easy money shorting the housing crisis may be over. There are signs that valuations are starting to become more attractive in housing, value players are now entering the space and the homebuilding group is now technically undergoing a bottoming process relative to the market.


Buying a house is starting to make economic sense
In California, which has been one of the hardest hit markets, buying a house is starting to make economic sense again. This recent report shows analysis indicating that in California, “home prices are dropping to a point where the cost of a mortgage and taxes equals rent”.


Sovereign funds buying real estate
There is also this report indicating that sovereign funds are buying US real estate: “one sovereign fund, said to have earmarked $29 billion to purchase foreclosed residential real estate, recently hired a West Coast mortgage broker and is starting to search for bargains.”

These funds tend to have a long time horizon and are typically value players. With the caveat that value investors do tend to be early, sovereign funds have the advantage of being not directly constrained by the tight credit conditions that exist in the US right now.


Homebuilders making a relative technical bottom
The chart below shows the chart of the S&P 500 Homebuilders relative to the S&P 500. As the chart shows, the group has broken out of a relative downtrend. The next phase is likely to be a sideways consolidation pattern.

Warning: I am not calling of a real estate bottom!

The Homebuilders are likely to go from free fall to market performer. Since my belief is that the market has a negative bias, this group is likely to continue to fall. However, the easy money is over from shorting this group. If you are short, cover your shorts.

Substantial downside risk remain in the group. Recently Barry Ritholtz at Big Picture outlined the risks to housing. Though his comments are directed toward the NAR Housing affordability index, these comments are valid with regards to my valuation comments. To paraphrase, my California affordability and valuation analysis:

• Assumes 20% down payment – who has that anymore?
• Ignores debt carried by homeowner – household balance sheets have deteriorated substantially
• Ignores falling FICO scores – see comment above about poor household balance sheets
• Other ownership costs are rising – e.g. property taxes, maintenance, heating, etc.

Tightening credit = more downside for housing?
Meredith Whitney, who correctly called the credit and housing crisis, is also forecasting further downside in housing because of tightening credit conditions.



Cover your housing shorts
An improvement in housing would be positive in general for the equity markets and the US economy. Bottoms don’t happen overnight and this is part of a process.

I would cover any housing shorts. The downside here is limited – don’t be greedy.