US ECONOMY (September 27th 2012): US Housing, Is the Trade OVER? Or is this Theme just warming up?

One great distraction over the summer (with the overall market moving in the opposite direction to economic data courtesy of QE), has been the US Housing trade.

As we know, US Housing fell off a cliff in 2007-2008. It began to recover in 2009, but stalled in 2010. We've been awkwardly waiting for US Housing to get going throughout 2011, and so far in 2012 the recovery in US Housing data has gotten back into its stride.

And so with a firmly bullish view on US Housing, with prices still depressed and mainstream sentiment still rock bottom, the leading housing data has led to great long trades in the US Housing sector in 2012. The data supporting that is shown below.

 

As we can see, the majority of US Housing data has shown a considerable recovery in 2012, after stalling somewhat in 2010-2011, coming from a low base after the housing crisis. New Home Sales, not included in the above screenshots, shows the same trend of recovery as Building Permits and Housing Starts.

While the whole market and US economy bounced back considerably from late 2011, the trend in the US Housing recovery has been smooth, decisive and consistent in making higher highs in many of the key indicators. This compares to an often confusing, bumpy ride for the rest of the US economy in 2012.

So, what has the effect been on the XHB (SPDR Homebuilders) in 2012? Let's look at the chart below:

The greyed area coincides with the malaise of US Housing data in 2010-2011. To be realistic in how we'd see the data in real time, it would take us until at earliest December 2011 to recognise a recovery in the US Housing data, looking at the charts. February-March might have been the most realistic time to recognise a visible recovery in the majority of indicators.

If we use the breakout in February (19.40 on the XHB for confirmation), we can see it has been a highly profitable trade for data-following market participants. The most recent peak in the XHB was 26.16 - that's a 35% gain in just seven months, from that data-supported breakout. Stock-picking in particularly leveraged housing plays would have yielded even more impressive returns, and taking early trades at the start of 2012 might have returned closer to 53%.


After such an impressive run, encouraged by continually impressive data and the prospect of further QE3-specific support for the Housing recovery - has the trade become too mainstream, and is it effectively over? This has been the sentiment from many traders who called the trade correctly earlier in the year (particularly Anton Kreil, who highlighted this phenomenal trade earlier in 2012 for Marketwatch: here).

The US Housing market is still "depressed", as Fed Chairman Ben Bernanke highlighted when QE3 was announced. The XHB has more than DOUBLED in less than a year, with the Housing Recovery far from guaranteed, and improvement still at the "green shoots" fragile stage. Is it time to take profits on this excellent trade? Did it come too far too fast?

Perhaps so. The surge has been so remarkable in recent months, that many have pointed to short-covering, a scrambling for shares amongst momentum traders, and fund managers leaping aboard the "hot sector", all helping housing stocks get overheated. Naturally, in the last week, we've seen a sharp sell-off as profits have been taken. The trade has reached the point where mainstream newspaper columnists have gotten on-board, a worrying sign for savvy "fast money" traders.

But on a grander, longer term timescale, does the data still hand us a reasonable opportunity to buy on any weakness? The trade may indeed be overheated, but what about the investment, in a sector that is still by-and-large hated by the public?

Mainstream market commentators may now be twigging to the recovery, and may be giving it column inches. But if the recovery is for real, and the housing market is still depressed, is this the first stage of a multi-year cyclical move?

Warren Buffett stated at the start of the year that the best investment opportunity in 2012 could be residential housing - and not for a six month trade, but for the long-term. When we look at the low base we start from in the Homebuilding sector, we know that the SPHB index peaked at over 1300 in 2005, was slammed down to just 112 in 2008, and now sits at around 500.

Something similar happened in 2003. The SPHB rallied hard from 300 to 560 in just three short months, as the trade went from "hated" to "overheated" between March and June - like today, this was supported by data showing green shoots of recovery. The trade fizzled out and became overdone. We saw a correction of 18% in just one month, late-comers left burnt in an overcrowded trade.

We all know the rest of the story - this was just the beginning of a huge bull run/bubble for US Housing, between 2003 and 2005, from 300 to 1300 on the SPHB index in two years. The trade may have fizzled out in 2003, but after cooling off, the recovery in data was enough to put a floor under prices - and the rally resumed a few months later.

So, while we'll continue to watch the data on that apparent 2012 Housing Recovery, keeping timeframes in mind might be the wisest idea.

The trade may be overheated, and today might or might not be the time to take profits on short-term bets. But if the recovery is a cyclical, sweeping improvement in depressed bricks and mortar, we might not be too quick to write off more returns in the Housing sector as we head into 2013 and beyond.


(Naturally, past performance and behaviour is not always a reliable guide to future returns, the comparison is a simple observation).

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GLOBAL ECONOMY (September 24th 2012): QE3 vs Economic Data, and Why We Won't Chase Risk

Since March 2012, global economic data in terms of quality leading indicators, has deteriorated in a strongly negative trend. The market gave us plenty of opportunities to sell the rallies once we got to this stage if we chose to. Even our leading market breadth indicators, the Bullish Percentage charts, wisely guided us to bearish conclusions in April, telling us to fade rallies and avoid buying the dips.

This broadly coincides with what you'd normally expect the market and economic data to do together. As Global PMI stats, business surveys and other (more mainstream) Unemployment stats start to peak, and fail to make higher highs, the market eventually stops making higher highs and pulls back, until the reverse is true. We usually get plenty of warning, and support from our market indicators, to allocate our portfolios appropriately.

However, the market is quite capable of ignoring economic altogether when choosing a direction. We saw this on a large scale in 2002, when the market became embedded in a negative mindset, the result of a confidence-dampening bear market from 2000 onwards. When it does this, it is often better to stand aside than attempting to pick market tops and bottoms, simply wait until the signals are stronger. In 2010, with the advent of QE2, it took at least a couple of months for the data to confirm the improvement in conditions (you'd have missed the bottom, but you wouldn't have been gambling on an unprecedented program working out).

Nevertheless, we're approaching the end of a frustrating summer for quantitative analysts, concerned with the ongoing decline in macro data from China, Europe, Japan and the United States, with Global PMI in it's worst state since 2009. Despite this, the market has surged ahead, troughing in June and rallying to new highs.

The explanation, of course, is Central Bank easing. The market knows that the Fed's actions rip up the sheets of negative economic data we're seeing today - at least, that is what the market expects. Indeed, knowing it may take three months for QE's effects to show up in the data, the market is rallying with no concern at all for economic conditions today.

At Big Macro Picture, as we've highlighted in recent months, the economic data hasn't gotten better. In fact, it has gotten considerably worse in some regions, which previously weren't a major concern. This remains to be true - although we remain glued to the data for signs of this trend reversing.

Despite this, our view is to appreciate the market's expectation of QE3's success. The last two versions of QE were constructive in reversing negative trends in US data. We don't want to follow that expectation without seeing proof in the data ourselves - the market could be set up for a considerable fall if QE fails to arrest the slump in US and Global economic conditions.

However, to draw directly bearish conclusions on the market based on today's data is not insightful, as of September 13th with the QE announcement. It isn't that the market is failing to see the poor quality economic data, it is simply reading past that, with the assumption that Global PMI will be positive again by November.

The market guessed correctly we would receive more Fed easing, and is also guessing that this easing will boost global economic conditions. Standing in the way of the market would have been unprofitable from June onwards - we feel that the reward for playing along in this guessing game is unfavourable compared to the risk.

As such, we continue to preach caution in having too much bullish or bearish exposure until the data confirms what the market indicators have been saying since June, whether QE works or otherwise. Even at the risk of missing out on further market gains, or at risk of missing a market shorting opportunity. It is foolish to overexpose yourself when the signals are conflicting, when the indicators are no longer leading the market, and when even top economists can't figure out what the real effect of QE3 will be.

It is worth noting that our favourite leading market indicator, the BPNYA, gave us the go-ahead to mark a new MEDIUM TERM bullish cycle beginning in early August. Our more sensitive version of the indicator gave us the signal to buy dips in relevant stocks from mid-June. Despite this, the conflicting bearish economic data has tempered our excitement towards the rally - and we feel no pressure in chasing performance amidst speculation and uncertainty.

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