Quirky but Accurate Indicator: Housing Sector Troubles Likely to Continue

Sometimes the oddest correlations make the best forward-looking indicators. This is certainly the case with lumber and the housing market. Here’s what this odd but accurate indicator ‘sees’ ahead for U.S. real estate.

Several times in the past we’ve looked at the correlation between lumber and housing – related ETF: iShares US Real Estate ETF (NYSEArca: IYR).

It’s an off the wall kind of an indicator, but it’s proven more accurate than any other housing indicator.

To get the correlation right, we need to set lumber futures forward by about 14 months.

The chart below does just that, as it plots lumber against the PHLX Housing Sector Index.

Lumber 514

As the gray oval on the right shows, lumber saw a big pop and drop in 2012/2013.

The two gray ovals to the left illustrate that the magnitude of such sizeable pops and drops tends to appear muted in the housing sector, nevertheless it suggested an eventual slowing of the housing market.

Lumber is currently at an interesting juncture, as lumber prices were unable to break above resistance and just fell to test support.

As of right now, lumber suggests that the housing market is not ‘out of the woods’. The housing blues may start all over if support for lumber fails.

This would not only affect multi-billion dollar ETFs like the Vanguard REIT ETF (NYSEArca: VNQ), or SPDR Dow Jones REIT ETF (NYSEArca: RWR), but also millions of Americans.

A proprietary analysis of supply and demand for the SDPR S&P Homebuilders ETF (NYSEArca: XHB) also shows that demand for homebuilding stocks is deteriorating.

 

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World is Now Richer Than Ever Before

Thanks to the phantom economic recovery, mainly noticed by rising share prices in stock exchanges around the world, aggregate global wealth has risen to a new staggering high … but Draghi finds a fly in the ointment.

Based on Allianz’s Global Wealth Report, global shareholders are richer than ever before.

The Global Wealth Report tracks global funds held in stocks of every country – like the S&P 500 (NYSEArca: SPY), Dow Jones (NYSEArca: DIA), internationally developed markets (NYSEArca: EFA) and emerging markets (NYSEArca: EEM) – cash and cash equivalent bank deposits, stocks and consumer funds at insurance companies.

Assets like real estate (NYSEArca: IYR), cars, and art are not included in the report.

The wealth of investors around the world reached a total of $150 trillion.

You’d think that’s good news, but Mario Draghi – Europe’s central bank president – found a fly in the ointment. It has to do with banks. In fact, Draghi is alarmed.

Here’s the full story: Europe’s ECB Warden is Alarmed … For the Wrong Reason.

Simon Maierhofer is the publisher of the Profit Radar Report.

Follow Simon on Twitter @ iSPYETF

Leading Indicator Projects Still Higher Real Estate Prices

According to some measure, real estate prices just recorded their biggest annual gain since 2006 and surveys show that Americans’ confidence in real estate is growing. Contrarians may consider this to be bearish, but one leading indicator doesn’t.

The S&P/Case-Shiller Home Price Index has become an important gauge of the real estate market. Index levels are updated on the last Tuesday of every month (that was yesterday).

The January data (the index uses a 3-month average and is published with a 2-month lag) showed a 0.1% month-over-month and an 8.1% year-over-year increase for the 20-city composite. The YOY figure was the biggest jump since the summer of 2006.

Compared to what we’ve gotten used to, this sounds grandiose. The first chart below puts last year’s gain into perspective. Although it looks less earth shattering, the increase is respectable.

Forward-looking investment decisions aren’t based on rearview mirror-focused analysis, so what’s next for the real estate sector?

Quirky but Credible Leading Indicator

In the October article “Is the Real Estate Recovery Here to Stay?” I introduced a quirky but credible leading indicator for real estate prices – lumber prices.

Lumber is a key component for every house, therefore seeing the connection between the raw material (lumber) and finished product (house) isn’t much of a stretch.

The October article plotted lumber prices set forward by one year against the PHLX Housing Sector Index and highlighted the correlation between major tops and bottoms (something we won’t do today).

 

Our conclusion, based on the leading lumber prices indicator, was that the housing recovery would last at least into mid-2013.

Why 2013? Because lumber broke through trend line support. At the time we didn’t know if this would end the lumber rally or not.

Today we know that lumber prices recovered and soared on to new recovery highs.

The October article noted that the correlation between lumber and real estate prices might be even better if lumber prices are set forward by more than 12 months. The chart below does just that. It plots the PHLX Housing Sector Index against lumber prices set forward by 14 months.

Obviously, the strong rally in lumber prices bodes well for real estate prices and real estate ETFs like the iShares Dow Jones US Real Estate ETF (IYR) or Vanguard REIT ETF (VNQ).

This indicator allows us to peek ahead a year or so and no further. The lumber rally has slowed as of late and various resistance levels (dashed red lines) are not far away.

It is possible that the real estate rally will run out of steam in mid-2014. If that’s the case, lumber prices will be our canary in the mine.

Is the Housing and Real Estate Recovery Here to Stay?

The S&P Case/Shiller Composite 20 Home Price Index just saw its sixth consecutive monthly increase (see chart below).

The index is a composite index of the home price index for 20 major metropolitan areas in the US. Many analysts look at the 6-month recovery (short red “tail”) and are ready to pronounce a permanent bottom for the housing and real estate market.

Obviously, this would be bullish for the iShares Dow Jones US Real Estate ETF (IYR), SPDR S&P Homebuilders ETF (XHB), and the overall real estate sector. But does this recovery have legs?

An Odd but Effective Indicator

It’s said that the end justifies the means and that may be the case with the quirky forecasting tool I’m about to introduce. This indicator has to do with lumber prices.

Lumber is a key component for every house and seems to play a role as a leading indicator. It seems that lumber prices tend to rise about a year before the housing sector.

The chart below plots lumber futures against the PHLX Housing Sector (HGX – not an ETF). HGX includes companies like Pulte Group, Standard Pacific, KB Home, DR Horton, Fidelity National Financial, Weyerhaeuser, etc.). I have set the lumber price forward 1 year to capture lumber’s leading indicator role.

The red arrows show the correlation between major highs and lows. Based on the tilt of the red arrows it might be even more appropriate to increase the lead from 12 to 15 months. Regardless, up until mid-2009 the correlation worked like a charm.

Enjoy it While you Can

Since mid-2009 the gyrations of lumber prices have been more pronounced and less correlated compared to the housing sector. I’m not sure why (massive monetary manipulation by the Fed likely plays a role). Assuming that the directional analogy will continue (or resume), lumber prices suggest that the housing recovery will last into mid-2013.

As of late, lumber prices have fallen through trend line support (black line), which is a bearish development. It will take time to determine just how bearish, but lumber futures suggest more weakness in mid-2013.

A resumption of the housing slump about a year from now would certainly harmonize well with our overall forecast for the stock market.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.