THE 18-YEAR REAL ESTATE CYCLE STILL HAS A LONG WAY TO GO BEFORE HITTING ANOTHER PEAK -- THE CASE-SHILLER HOME PRICE INDEX NEARS SIX-YEAR HIGH -- RISING REITS AND HOMEBUILDERS ARE LEADING INDICATORS -- WE'RE STILL IN EARLY STAGES OF REAL ESTATE UPTURN
THERE IS AN 18-YEAR REAL ESTATE CYCLE ... My 2013 book entitled "Trading With Intermarket Analysis" described the existence of an 18-year real estate cycle. In other words, real estate tends to peak about every 18 years. This reliable pattern has been traced back to the 1800s. Credit for its discovery goes to economists Homer Hoyt in the 1930s and Clarence Long in 1940. I wrote about the 18-year cycle to explain that real estate (and housing in general) operates in a difference cycle than other financial markets. Since publication of that book, I've run across more research on the 18-year real estate cycle which I'd like to share with you. Let's start with the good news. The last real estate peak took place in the 2006-2007 period. That means that the next real estate peak isn't scheduled until 2024-2025. That means this upturn in real estate (and housing) still has a long way to go. Chart 1 shows the S&P Case-Schiller National Home Price Index over the last 14 years. Home prices started dropping in 2007 and hit bottom in late 2011. That roughly matches the historical average from real estate peak to trough which is about four years. From that trough, prices usually continue rising for the next 14 years.
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Chart 1
LAST REAL ESTATE PEAK WAS RIGHT ON TIME... In September 2007, Fred Foldvary published a work entitled "The Depression of 2008" (Gutenberg Press, Berkeley, CA). Foldvary based his bearish prediction for 2008 on a scheduled peak in the 18-year real estate cycle. By his count, the last prior real estate peak had taken place in 1989. That put the next scheduled peak in 2007. His 2007 publication suggested, however, that the real estate peak had actually occurred during 2006. He further observed that economic downturns have usually occurred two years after the real estate peak. Hence his prediction for a severe economic downturn during 2008. [Historically, real estate peaks have been associated with severe recessions (or Depression) and an average loss of 50% in the stock market]. Chart 2 shows the S&P 500 Case-Shiller Home Price Index peaking two years before the S&P 500, just as Foldvary predicted. [Prior real estate peaks in the late 1920s, and early 1970s, also led to a very weak economy and large market losses].
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Chart 2
HOMEBUILDERS ARE LEADING INDICATORS ... Stocks tied to housing and real estate often act as leading indicators for the real estate cycle. Chart 3 overlays the PHLX Housing Index (brown bars) and the MSCI U.S. REIT Index (black line) on the Case-Schiller Home Price Index (shaded area). The chart shows homebuilders peaked in 2005, which was two years before the peak in REIT Index and home prices. [I remember pointing that out at the time, and suggested the plunge in homebuilders during 2006 warned of a housing peak]. Homebuilders and REITs bottomed during 2009 when home prices were just starting to stabilize. The second homebuilder bottom in late 2011 preceded the 2012 upturn in home prices. REITs are now trading at an eight-year high, while homebuilders appear poised to resume their uptrend. [Falling bond yields have increased the popularity of REITs which are big dividend payers]. The fact that homebuilders hit bottoms in 2009 and 2011 before turning up in 2012 also fits the historical average. Another economist named Fed Harrison has pointed out that it normally takes two years from real estate peak to trough, and another two years to recover (The Power in the Land, 1983). That pretty much describes the bottoming process in homebuilders. The good news is the that 14 years after a bottom are usually upward.
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Chart 3
MORE RESEARCH ON THE 18-YEAR CYCLE... The September issue of the "The Society of Technical Analysts Journal" (based in London) included an article entitled "Why Traders Need to Understand the 18-year Real Estate Cycle" by Akhil Patel. Mr. Patel puts the last three real estate peaks in 1973, 1989, and 2007 -- and the last three real estate troughs in 1975, 1993, and 2010. His optimistic forecast is that "we are now in the process of moving into the next cycle expansion". His bullish forecast divides the 14-year real estate upturn into two seven year periods which are interrupted by a modest mid-cycle slowdown. By his reckoning, the mid-cycle slowdown isn't due until 2018-2019. He also observes that the 18-year cycle is generally divided into 14 up years followed by 4 down years. That observation explains a miscount I made in my last book. I put the last real estate bottom in 1992 and called for a likely top nine years later. [An "ideal" 18-year cycle would see nine up years and nine down years]. What I didn't know at the time is that the up part of the cycle lasts for 14 years, which put the proper target for the next housing peak in 2006 (14 years after 1992) -- right on schedule. UPDATE: My Wednesday message showed the Dow Jones U.S. Home Construction iShares (ITB) nearing the top of a nearly two-year trading range. The brown line in Chart 4 plots a relative strength ratio of the ITB divided by the S&P 500. The RS line fell from spring 2013 until this October when it started rising. An upward break of the falling resistance line would signal a positive upturn for homebuilders. That would be consistent with a rising real estate cycle.
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Chart 4
DEFLATIONARY FORCES SHOULD HOLD TREASURY YIELD DOWN... One of the biggest concerns for 2015 is the prospect for higher interest rates in the U.S. While it's true that the Fed may start to hike rates later in the year, that doesn't mean that bond yields will rise very much. The Fed controls short-term rates, while bond yields are determined by economic strength, inflation expectations, and foreign markets. Chart 5 shows two deflationary forces that should keep U.S. bond yields under control this year. The plunge in the CRB Index during 2014 suggests that any threat from commodity inflation is nowhere in sight. [The fact that the U.S. Dollar Index is nearing a ten-year high should also keep commodity prices from rising much this year]. The second factor weighing on Treasury yields is the plunge in foreign yields. The blue line in Chart 4 shows the German 10-year yield falling to 0.50% which is the lowest in history. [The five-year German yield has turned negative for the first time ever]. The spread between the 10-Year U.S. and German yields has reached the widest level in 15 years. Foreign money moving into higher-yielding Treasuries (also attracted by a stronger dollar) should keep Treasury prices from falling too far and yields from moving too high. All of which suggests that fears of rising rates this year may be somewhat overblown.
