The epicenter of current market tremors is the depressed housing sector. As contrarians we need to consider whether the psychology is sufficiently pessimistic so as to create a bottom and thus offer a huge buying opportunity. Are we there yet? Has the housing market hit bottom or is there still more pain to come? This past week saw a resurgence in sub-prime fears. Heavyweight Merrill Lynch announced that bad debts from mortgage related securities ballooned by $3.5Bn to $7.5Bn. The stock gapped lower on the news losing over 6% in 1 day.

Memories of the August swoon came flooding back and the market was once again filled with fear.

Therefore, it stands to reason that if underlying debt problems are caused by real estate distress, we need to take a long hard look at that market to see if there is more to come. Before doing so, we need to refresh our memories as to what the prevailing psychology would look like at a market bottom. What causes a market, any market, be it real estate, stocks, bonds or commodities to finally reverse? It certainly isn’t fundamental valuations. Markets are notorious for biding up expensive assets and for turning bargains into give aways. How about an exhaustion of buyers and sellers? That sounds more plausible. If everyone has jumped on (or off) the bandwagon then it stands to reason that nobody is left to support the prevailing trend. That’s when markets tend to reverse, when psychology is at its most extreme. When everyone has bought into the idea that a stock can only go higher or lower – Presto! You have the ingredients for a reversal. Reality is never as clear cut because it is difficult to assess the prevailing level of fear. That’s where charts come in useful. Charts provide us with the capability to look beyond the noise and view, unemotionally, what’s really going on. That said, lets see if we can view the homebuilding stocks in light of the above: Chart 1: Centex Homebuilder Daily chart with internal divergences

 

We have used homebuilder Centex Corp as a proxy for the housing sector. The daily action is instructive. Centex experienced significant selling 2 weeks ago falling 20% to $24. But this past week, when the financial sector was shaking, Centex actually rose. More importantly, from a technical point of view the new price low was not confirmed by market internal measures of MACD and RSI which made higher lows (blue lines). This is classic bottoming action on the daily chart. The monthly chart is probably even more surprising:

Chart 2: Centex Corp Monthly has achieved its technical target of $25

 

The inception of the housing boom can be traced back to the end of the 2001/2 bear market. The Fed dropped interest rates through the floor – slashing short rates to 1% and in the process igniting a mortgage borrowing frenzy. Stocks of homebuilders such as Centex went up over 500% between 2002 and 2006 at which point the boom probably exhausted itself for no other reason than those who wanted to get into the real estate market were already in. The psychology was overwhelmingly bullish but nobody was left to buy. Thus the subsequent 70% ‘correction’ in Centex from 2006 to today. We alerted our subscribers to the technical risk when Centex fell below a large head and shoulders pattern at $40 (solid blue line) and marked off $25 (dashed blue line) as the projected target.

That target has now been fulfilled!

Bearing in mind that the NASDAQ CRASH of 01/02 was a drop of 80%, it is not unreasonable to expect a bottom in the housing stocks at these levels. However, and as with the NASDAQ, is it improbable to expect homebuilders to fully recover anytime soon. Whilst we have focused on homebuilding stocks, we are essentially using them as a proxy for the real housing market. The real bricks and mortar housing market will probably only bottom in 6-9 months time (assuming CTX has bottomed). This is common in real illiquid assets versus liquid financial assets. But we should not forget the bigger picture, there is an ongoing flight from paper money to real assets, a trend which real estate will ultimately benefit from. We think US homebuilders may be a contrarian buy in this area!

More commentary and stock picks follow for subscribers…

— Greg Silberman CA(SA), CFA

greg@goldandoilstocks.com

I am an investor and newsletter writer specializing in Junior Mining and Energy Stocks and small caps listed in the US, Canada and Australia.  

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This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.