Thursday, 27 September 2012

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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