17 SEPTEMBER 2011 BY MCCLELLAN FINANCIAL
Tom McClellan – McClellan Market Report
Sentiment could not be much worse for the U.S. housing market than it is right now. And why shouldn’t people be pessimistic? All of the governmental efforts to stimulate a housing rebound, so people start thinking that if the government cannot fix it, what can?
Meanwhile, most people are unaware of a major rebound brewing for the home building stocks. That is because most people are not readers of our publications.
This week, I’m revisiting a topic addressed here before, concerning the way that housing stocks tend to follow in the same footsteps as lumber futures prices. The price plot of lumber futures has been shifted forward in the chart by a year to reveal how the same patterns tend to show up in the PHLX Housing Sector Index HGX about a year later. It is not a perfect correlation; it is merely very good.
A year ago, lumber prices were finishing the bottoming process after pulling back to test the top side of a broken declining tops line. Lumber prices then surged into early 2011, which means that we should expect the HGX to see a similar surge into early 2012.
This next chart looks at the same relationship, but zooms in closer.
One important point to notice is that the lumber price top a year and a half ago was a lot sharper of a blowoff move than what ended up being seen in the HGX’s own topping structure. There is a very good reason for this. At the end of an ordinary up move in lumber prices, the Maule earthquake struck Chile on Feb. 27, 2010. That earthquake shut down lumber operations in that country, disrupting supplies and sending lumber buyers scrambling for alternate sources.
Once the lumber and other markets had a chance to recover, prices normalized and came back down from that sharp blowoff top. The HGX decline in 2011 matched the timing of the lumber decline in 2010, but not the magnitude.
The lessen here is that lumber tends to respond a year ahead of time to the economic forces which will strike the housing market a year later. I liken this to a wave passing under the end of a long pier. The same wave eventually strikes the beach, and so if you know the length of the pier and the speed of the wave, you can know when the wave will hit the beach.
The same economic wave which caused a decline in housing stocks in 2011 had caused a decline in lumber prices a year earlier. Lumber’s price pattern also reflected a temporary anomaly from the Chile earthquake, which was not a factor that affected housing stocks. That’s the hard part with using a leading indication like this, or any of our other Liquidity Wave relationships: one has to figure out which movements are due to economic forces, and which are due to something putting a thumb on the scale.
Lumber’s price rally in late 2010 was not due to any one-time factors like earthquakes, and so it seems much more likely to have its full echo observed in the prices of home builder stocks.