Today's Market Observation  04.21.2009  Mon  Tue  Wed  Thu  Fri  Barbera Archive

The Invisible Crash for Real Estate

by Frank Barbera, CMT | april 21, 2009

As I noted last week, the odds are high that in the coming months an inventory replenishment cycle will likely unfold, and in the process will give some long overdue lift to the moribund economic data. In my last article, I also tried to point out that while the headline numbers are bound to improve, that despite the improved news headlines, very little else is likely to have anything but an ongoing ‘recession’ feel. In fact, I would argue that ultimately, the contraction phase currently being seen is but a ‘warm up’ prelude to a much larger economic decline, which in the end will likely only be able to be characterized as a “major depression.” The timing for the second phase of this large contraction is still hard to predict, as if the current Administration is successful in re-inflating the markets, the second leg of contraction could be pushed out several years. In that event, we would have the current contraction followed by a respite period of virtually stagnant, possibly slightly improving conditions, followed by a second and likely much more intense ‘crash’ phase a few years (2-4) down the road. In the end, much higher interest rates of all stripes are on the way, and with them eventually, a currency panic the world will remember for decades.

That sequence, which is the real end-game, will be brutal on the economic data, especially for Real Estate which will likely remain mired in a constant dollar bear market for the next 5 to 10 years. So what do I mean by a ‘constant dollar bear market”? The answer to that is best understood by a look back at the 1970’s. Back then, a decade of high inflation took hold leading to the term stagflation, a condition of no growth and high inflation, sort of a worst of all worlds' economic outcome. Back then the stagflation produced a constant dollar crash in the value of stocks which under performed inflation for nearly 17 years. At the time, James Dines authored a book called, “The Invisible Crash” which pointed out how for 17 years between 1965 and 1982, the DJIA went giant sideways in a trading range between 550 and 1000. Over that same period of time, shown below by the dashed lines, the rate of inflation continued to accelerate (CPI is the bold line overlaid against the DJIA in top clip).

Above: Top DJIA with Inflation, Bottom: The Purchasing Power of Stocks. Constant $ DJIA

As a result, with stocks moving nowhere but sideways, and inflation moving steadily higher, if one were to plot stocks in real, inflation adjusted, what is called, Constant Dollar terms, the result is shown in the plot on the lower clip. This decline is the Invisible Crash which Dines referred to, and which reflected the loss of purchasing power exhibited by stocks during the 1970’s as stocks failed to keep up with inflation.

Flash forward to the decade of the early 2000s and we see a bubble in Real Estate which was supported by an even larger bubble in credit. The bursting of today’s mega-credit bubble is easily the most substantial event in the financial world since the Great Depression. Looking back at history’s greatest Bubbles, there are several major rules one can divine. First off, bubbles this big tend to take at least 10 years to work off the excess and return pricing to a stable climate. Never has a bubble this big managed to be worked off in two years. Second, the asset class at the center of the Bubble, be it shares of the South Sea Company in the 1700’s, Tulips in Holland in the 1630’s, Stocks in Japan in 1980’s, Gold in the 1970-80’s, Internet Stocks in 2000, once the asset class has busted, it has invariably stayed busted for at least 10 years.

In the US, domestic residential housing was the star performer of the latest mega bubble, what arguably was the greatest bubble of all time. What’s more, it was financed by ultra loose, creative credit practices which the world will not be returning to any time soon. As credit continues to contract over the balance of this decade, it will tend to force prices down in all forms of Real Estate over the next few years. More specifically, we believe that while the nominal price of Real Estate, both Residential and Commercial, could move in a very similar extended trading range to the DJIA in the 1960’s and 1970’s, (with some up years and down years), overall, when plotted against the forthcoming rate of inflation, Real Constant Dollar Real Estate values will be moving steadily lower, as Real Estate experiences its ‘lost decade’ and surrenders to an invisible crash.

Once inflation is reigned in, post a currency crisis, Real Estate values will be shown to have been horrifically deflated, likely to a degree that most investors today could not begin to imagine. In the 1960 to 1980 episode stocks lost nearly 75% of their purchasing power, and in the coming decade I would argue that by the time an Inflationary Depression has run its full course, Real Estate prices high-to-low in Constant Dollar terms will be down that much and possibly more. Following that type of outcome, it will be decades before anyone begins to contemplate a home as an investment vehicle again. Under-pinning this forecast is also the attendant time factor that will be needed to restructure the US economy, which has been falling apart at the seams for the balance of the last two decades, during which time a short sighted focus on sequential quarterly profit gains distracted the masses from a gutting of long term means of production. Without a manufacturing base, the US is now a price taker, and has become sorely import dependent. This outcome worked very well while the Dollar was seen as a store of value in recent decades, but will collapse into an acute inflationary crisis as confidence in the Dollar falls apart in the wake of huge government deficits sure to arrive in the years ahead.

 

Above: top clip (US Median Home Price with CPI Inflation) and lower clip: Constant Dollar Median Home Prices, Home prices adjusted for inflation (or put another way, the Purchasing Power of Homes)

In the chart above, I show the downside acceleration now taking place in the nation’s Median Home price which is now moving back to late 2003 levels and about to break its long term rising trend. In my view, even once inflation rates re-accelerate and nominal home prices stabilize, the annual gains seen in housing prices will likely badly lag underlying inflation rates, causing the lower graph, Constant Dollar Home prices to continue to decline. Ultimately, housing could erase much of the gains seen during the 1980’s and 1990’s in much the same result as what occurred in Japan, only derived by a different series of economic forces. Don’t think this can happen? Just watch. As for Real Estate, the coming decade will be a long period of water torture with nothing but negative real returns. With this in mind, we turn our attention this week to the action of the Homebuilding stocks which appear to be ripe for a renewed major decline. In my view, both the Commercial REITS, the Home Builders, and of course, the Financials remain key epicenters in this crisis, and as a result good indicators to bear close watching for clues as to just how long this bear market rally will last.

In this week's technical update, I apply a sharp focus to the action of the Homebuilders, where over the last few days a wide array of technical indicators have come off a series of major overbought values. From short term gauges like Up to Down Volume and the McClellan Oscillator, to more medium term gauges like the Haurlan Index and the ARMS Index, Homebuilding stocks appear to be establishing another major peak.

Above: Short Term Ratio of Up to Down Volume for GST Homebuilders

Above: The Haurlan Index for GST Homebuilders coming off medium term fully overbought condition.

Above: GST Homebuilding Index with Medium Term Advance-Decline Ratio

Above: Long term ARMS Index for Homebuilders is fast approaching bear market overbought values at 1.00, the middle of the three dashed lines. The prior three readings (see arrow) accompanies important tops in the Homebuilders.

In my view, one of the key variables to be watching closely in the weeks ahead is the continued action in the 10 Year Bond yield. Both 3.00% and 3.30% are big resistance boundaries. Any move above 3.00% would be an initial bearish indication and any sustained move back above 3.30% in my view would start to take on the dimensions of a more major negative for the broad market. Homebuilders, not surprisingly, are especially sensitive to long-term rates. In the past, sharp moves in long-term rates have not taken very long to exert a strong impact on Homebuilding shares. In my view, rates appears to be trading in a pattern consistent with steady upside pressure at work. It appears as though bonds are focusing heavily on the huge quantities of new issuance dead ahead, and the noteworthy drop off in recycled foreign capital.

Above: Homebuilding Stocks compared with 10 Year Bond Yields, in late 2008, the sharp drop in yields stabilized the Homebuilders.

Above: A retrospective view, the last time rates rose, a surge in rates in early 2006 caused the Homebuilding stocks to break down from a large H&S Top. A second, smaller surge in rates prompted the next break down in May 2007.

As I see it, a surge in long-term interest rates could easily be the catalyst for a renewal in the down cycle in Homebuilders. Almost two years ago in this column I forecast a major crash in Homebuilding stocks, long before even the first hints of the current bear market came into view. I told readers the decline would be historic, and while it has lived up to that expectation, I still do not see a final low. In fact, looking at the long term chart for Homebuilders, I would not be surprised to see the entire sector down another 50% to 60% over the next 12 months from already “low’ levels.

Above: Long term Elliott View of Homebuilders, the bear market in this sector still has a long way to go.

Below: Current Bear Market structure for Home Builders.

Above: Updated Elliott view on Homebuilders, would not be surprised to see an additional
50% decline in Homebuilding shares in the next 12 months. Still look very weak.

In my view, there is a reasonable chance that Homebuilding stocks could make new bear market lows over the course of the summer, despite the fact that the overall stock market will likely bounce further in the months ahead. For now, I am not saying this to encourage readers to speculate on the short side of Homebuilders. Instead, I believe that Homebuilders could be a useful leading indicator for the market as a whole in coming months. A set up that would be telling would be to see a broad stock market recovery into August, SPX 950-1000 during which time, the Homebuilding stocks lag the market and then slip to new bear market lows. That kind of action would argue that the bear market could come back in full swing later this year. For now, the S&P has peaked the first phase of its bear market rally, with a counter trend declining phase dead ahead over the next few weeks. Once that is complete, a second, likely robust advance should follow over the summer months, lifting the S&P to higher highs.

That’s all for now,

Frank Barbera
The Gold Stock Technician

Copyright © 2009 All rights reserved.

contact information

Frank Barbera
The Gold Stock Technician
PO Box 48072
Los Angeles, CA 90048
Email | Observation Archive | Other FS Editorials | FSN News Team