February 17th, 2013
by Jeff Miller, A Dash of Insight
Is the housing rebound for real?
The question has special significance because the consensus economic forecast assumes improvement in this sector. This week's economic data include the most important reports on the housing market. The FOMC minutes will also provide insight into Fed policy on the purchase of mortgage securities. With Congress on an extended President's Day recess, I expect housing to be the theme of the week.
The Background Evidence
On the positive side there is the evidence of the market. The iShares Dow Jones Homebuilder Index shows the dramatic rally since June, 2012 – about 85%. The gains have been supported by commentary from executives at the major industry leaders and the top real estate publications. For many, it creates a sense of déjà vu.
Some pundits have called this quite accurately, including Schwab's Liz Ann Sonders. In an interview with TheStreet.com she opines that we are still in the first inning.
On the negative side we have Yale Professor Robert Shiller, widely acclaimed for predicting the housing bubble. Dr. Shiller is also the co-founder of a licensed home price index and also a sector based ETN using his methods.
In two recent interviews he makes the case for caution.
- Housing is not a good investment vehicle, when adjusted for inflation, maintenance costs, and technology improvements. (Via Sam Ro coverage of a Trish Regan interview).
- Overall optimism is too premature. In an interview with Henry Blodget at Business Insider, Dr. Shiller carefully distinguishes himself from an unnamed "perma-bear guy." Here is a key response:
Blodget: So what is your sense of the next five years? Do you think we've hit bottom in the housing market or do you have to stratify it that way?
Shiller: I think that we might have [hit bottom], but my biggest sense is that probably nothing dramatic happens either way. If the Pulsenomics survey is right, and it's up between 1 and 2 percent real, that's plausible to me. But also down 1 or 2 percent real, that's plausible. I'm sorry I don't have a more precise forecast.
Which approach is more plausible? Has housing bottomed? What does the answer mean for the individual investor? As usual, I have some thoughts on this question which I'll report in the conclusion. First, let us do our regular update of last week's news and data.
Background on "Weighing the Week Ahead"
There are many good lists of upcoming events. One source I especially like is the weekly post from the WSJ's Market Beat blog. There is a nice combination of data, speeches, and other events.
In contrast, I highlight a smaller group of events. My theme is an expert guess about what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.
This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.
Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!
Last Week's Data
Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:
- The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
- It is better than expectations.
This was a good week, both for data and for earnings.
- Retail sales were pretty good (see Steven Hansen at GEI for the full story).
- Housing inventory is down 16%, y-o-y. And yet another survey shows prices higher. (Both via Calculated Risk).
- Weekly jobless claims dropped to 341K, well below expectations.
- There is a U.S. budget surplus! Let us not get carried away. John Lounsbury shows the reasons behind the one-month surplus, an artifact of law changes and timing. The overall deficit picture is improving, as this chart from Scott Grannis shows:
- Earnings and revenue beat rates have been strong. Here at "A Dash" we report on earnings whether good or bad. Many sources always take the negative side. They suggest that earnings estimates are always too optimistic. They later say that the "bar was set too low." More recently some have argued that you must ignore earnings and look to revenue. Even by that standard the Q412 earnings season has been strong. Here is the chart from Bespoke showing the revenue beat rate. The full article has several more excellent charts and additional analysis.
- M&A deals are at a new peak, healthier than those in the past, indicating solid value. Check out the powerful commentary from Josh Brown, explaining why this is the Healthiest M&A Boom in Decades.
- A new source for accountability. PunditTracker lets you nominate pundits and predictions, assign grades, and follow the scores. It is a bit early to judge, but the current returns are still interesting.
- Michigan sentiment posted a solid rebound. Here is my favorite chart of this indicator via Doug Short:
There was some bad news, especially on the political front.
- Industrial production declined 0.1% in January versus an expected gain of 0.2% or so. New Deal Democrat points out that the story was not all bad. There were significant revisions to the November and December reports. With the revisions included, the overall level is actually better than expected. (See also Doug Short in the indicator update below).
- Earnings growth estimates seem too optimistic. Check out this chart from Eddy Elfenbein and see his analysis:
- The sequester is coming. The State of the Union speech did not bridge the gap. The Democratic Senate proposal is a non-starter. No one on either side is upbeat about an eleventh-hour solution. Meanwhile, Congress voted to recess until February 25th. But don't worry. In the wake of last week's asteroid news, House Committee hearings are already planned!
- The end of the payroll tax cut is hurting retail sales. A leaked email from a Wal-Mart executive suggests that February sales are terrible. This hit both retail stocks and the overall market on Friday. Higher gas prices add to the concern.
Suspicious trading in Heinz options suggests that someone had advance information. A level playing field is important for investor confidence, so this deserves SEC attention. Paul Vigna's story reports how the SEC is freezing the Swiss trading accounts involved and also acting to determine who is involved.
The Indicator Snapshot
It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:
- The St. Louis Financial Stress Index.
- The key measures from our "Felix" ETF model.
- An updated analysis of recession probability.
The SLFSI reports with a one-week lag. This means that the reported values do not include last week's market action. The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.
The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.
The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." I have now added a series of videos, where Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50's. I have organized this so that you can pick a particular recession and see the discussion for that case. Those who are skeptics about the method should start by reviewing the video for that recession. Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.
I have promised another installment on how I use Bob's information to improve investing. I hope to have that soon. Anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning. Bob also has a collection of coincident indicators and is always questioning his own methods.
I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index. They offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. RecessionAlert has developed a comprehensive package of economic forecasting and market indicators. I will try to do a more complete review soon. Dwaine Van Vuuren also has an excellent data update, demonstrating how the coincident data have reduced recession prospects.
Doug Short has excellent continuing coverageof the ECRI recession prediction, now well over a year old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. His latest comment points out that the public data series has not been helpful or consistent with the announced ECRI posture. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.
The average investor has lost track of this long ago, and that is unfortunate. The original ECRI claim and the supporting public data was expensive for many. The reason that I track this weekly is that it is important for corporate earnings and for stock prices. It has been worth the effort for me, and for anyone reading each week.
Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.
Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. About a month ago we switched to a bullish position. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings stabilized at a low level and improved significantly over the last few weeks. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure remains elevated, so we have less confidence in short-term trading.
[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]
The Week Ahead
This abbreviated trading week brings some interesting data.
The "A List" includes the following:
- Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator. Weather effects will complicate our interpretation.
- Leading economic indicators (Th). This is still a favorite for some.
- Building permits (W). My favorite leading indicator for housing.
- FOMC minutes (W). The market is (mistakenly) poised for any fresh news about the Fed.
The "B List" includes the following:
- PPI (W). Expecting little, but important if perceived as a change in the trend.
- CPI (Th). Expecting little, but important if perceived as a change in the trend.
- Housing Starts (W). This is a key element of the economic rebound, so it is important to follow.
- FAFA home prices (T). These are the prices from the regular homes in the government market.
It is the open period between Fed meetings, so there will be plenty of speeches, especially on Thursday.
Trading Time Frame
Felix has continued a bullish posture, now fully reflected in trading accounts. It was a close call for several weeks. Felix did pretty well last year, becoming more aggressive in a timely fashion, near the start of the summer rally, and getting out a couple of months ago. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. Felix has been cautious, but still has caught most of the rally, and done so with less risk.
Investor Time Frame
Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.
Prof. James Hamilton has a great post explaining your choices: "The question is maybe not what is a good investment right now, but instead what is the least bad investment." He writes further as follows:
But what else are you going to do? Low as the dividend yield is on stocks at the moment (2.04%) , it's still better than what you can get on a 10-year U.S. Treasury bond. Moreover, any inflation in the prices of the goods and services that firms sell, as well as any profit gains associated with a larger market, should boost those dividends over time, whereas inflation would continue to erode what you make on the Treasury. Or you might look at a Treasury Inflation Protected Security, whose coupon will rise with the headline CPI. That's currently yielding a hefty -0.57%. Anybody want to sign up for that 10-year plan?
High-yield bonds are dangerous, partly because of the stampede for yield. (Formerly referred to in my series merely as the Quest for Yield). David Schawel (in an article highlighted for us all by Abnormal Returns), writes as follows:
Greater price risk now exists: The devil is always in the details, and price is an important risk that most corporate bond investors, in my opinion, are overlooking.
Gold is currently on a "sell signal" according to Georg Vrba, whose technical model follows the Coppock indicator.
The last sell signal was at the end of November 2012 and no new buy signal has so far appeared. What is needed now for an early buy signal is a sustained upward move of the gold price to over $1,700 during the next few weeks, something which is certainly not outside the bounds of probability.
Meanwhile, we have continuing "headline risk." Buying stocks in times of fear is easy to say, but so difficult to implement. The big-shot experts on TV are calling you the dumb money, even when you have been right! (in case you missed it, see this discussion).
Almost everyone I talk with wants to out-guess the market. The problem? Value is more readily determined than price! Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out." For many, the big shift is on.
Scott Grannis provides a useful chart of fund flows and writes as follows:
This follows six years during which equity funds experienced huge and almost relentless outflows. Has the tide finally turned? Are investors now finally becoming bullish after four years of strong equity gains? Perhaps, but if this is the beginning of the return of bullish sentiment, it likely has a long way to go before it runs out of gas.
This can all seem confusing for the individual investor. To help, I have collected some of my recent recommendations in a new investor resource page -- a starting point for the long-term investor. (Comments and suggestions welcome. I am trying to be helpful and I love feedback).
Do we have a bottom in housing? This type of question is very dangerous. It raises a topic that we all think we know about and we all have an opinion. We are tempted to substitute what we see in our neighborhoods (relevant but not decisive) for actual data. Things are looking pretty good in my town, but I would like to know more. I recognize that I am not an expert on housing. I am an informed consumer of the reports of housing experts. So are you, whether you realize it or not!
When I look for expertise, I have three paramount thoughts:
- Is the information something that can create value in my investments?
- Does the source change conclusions with the evidence?
- Are the changes timely?
I have occasionally been accused of credentialism in favor of academics and degrees. I object, since I seek the best information from all sources. Sometimes this means that I regard the world's leading experts on monetary policy at the zero bound as superior to some bloggers who are "self-taught in Austrian economics" (the most dangerous words in the investment lexicon). On this occasion I suggest that Dr. Shiller is failing on all three counts. His work is solid by academic standards, but it is much too slow to change and essentially not profitable for investors.
John Paulson was timely in spotting the housing risk. He has a new viewpoint.
Bill McBride at the Calculated Risk blog earned the respect of everyone, including leading economists. This recent feature in the Los Angeles Times tells you what you need to know.
From our perspective, he meets the key tests:
- He told us that the "Housing Bottom is Here" a year ago.
- He follows inventory carefully, remaining skeptical of industry sources.
- He understands the big picture, showing how housing spills over into the general economy.
The housing stocks are too rich for me, although we have sometimes held ETF positions in the Felix portfolio. My current focus is on the implication for the overall economy. The story continues to be both important and positive. Housing has been a multi-year subtraction from the economy. Even a modest rate of growth represents a major change with implications for consumers and employment. This helps to explain the spending and sentiment strength, even in the face of the payroll tax change.