Why Is A Strong Housing Report Is Good For The Stock Market

• Subdued response to great housing numbers is a bullish sign
• What does this mean for housing stocks?
• Housing conclusion
• Small cap big profits?

Subdued response to great housing numbers is a bullish sign

Sometimes very important developments for the market receive widespread attention, quickly experiencing a swing in sentiment as prices move significantly higher. That’s usually a time to expect some kind of reversal since everyone and his dog is aware of the development and it becomes fully factored into the price. Last week, I think we witnessed the opposite, as a blockbuster increase in housing starts was reported but attracted miniscule attention. Part of the jump was due to a depressed September number, so some could argue that it was not so significant. Even so, the new numbers pushed starts into a new post-financial crisis level high. But why am I making such a big thing about this? The reason is that housing starts are a really long leading indicator. Financial indicators usually move before starts, but starts are the first thing to reverse that you can touch and feel, and that means that we have a reliable piece of evidence that the economy has emerged from its corrective path of the last two years and is set for an improvement in its growth rate. There is no indication of the magnitude and duration of any gains, but right now the important thing to note is that the trajectory is positive. Remember peaks in housing starts generally lead recessions by one or two years, sometimes longer.

Chart 1 compares housing starts ($$HSNGSTARTS) to industrial production ($$IPI), a coincident economic indicator. Other coincident series would include nonfarm payrolls, GDP and so forth. Note, that starts tend to have a longer lead time at economic peaks than at troughs, so the new high is very encouraging from an economic, and therefore stock market point of view.

The principal reason why starts move ahead of the economy is due to their sensitivity to interest rates. The higher the rate, the more expensive mortgage payments are which is often the largest cost of owning. Higher rates therefore depress demand. Most of the indicators I follow are pointing to higher interest rates, so this may create a problem for the continued growth in starts scenario.

Chart 1

An example is shown in Chart 2 for the 30-year yield ($TYX). Here, you can see that the yield itself has completed and broken out from a base and simultaneously cracked its 2015-16 down trendline. Moreover, the long-term KST is about to trigger a primary trend bull signal by crossing above its MA. Currently it is running into resistance as flagged by the thick blue line, and that may prove to be a temporary barrier. However, the course does seem to be set for higher rates.

Chart 2

The key in all this, is to see how sensitive the housing start numbers are to changes in interest rates. For this we turn to Chart 3, which compares the housing start data to a ratio of housing starts to the 30-year bond price ($$HSNGSTARTS:$USB). When the ratio is rising it tells us that housing starts are outperforming bond prices and vice versa. The joint trendline breaks indicate that reversals in both series offer reliable signals of reversals in starts. What’s impressive is that the ratio has risen sharply, even in the face of higher rates. The breakout suggests that this is the beginning of a worthwhile trend. Even though, it does not tell us the duration of that trend, it’s certainly a near-term positive for the housing numbers.

Chart 3

What does this mean for the market and housing stocks?

In Chart 4, we compare the S&P Composite ($SPX) with housing starts ($$HSNGSTARTS) over the last decade. In this period, housing starts experienced a long lead time between their peak and that of the S&P, so with the housing numbers still rising and the long-term KST for the S&P, having just gone bullish, that seems like a formula for a stronger stock market through at least the first quarter of 2017.

Chart 4

Chart 5 brings us to the stocks that actually make the stuff in the form of the SPDR Housing ETF, the XHB, and the iShares US Construction (ITB). Housing tends to be a leading stock market sector, but is not showing any signs of upside leadership at this point. As you can see, starts are breaking to the upside as the ETF's are testing key support trendlines. This is not the preferred relationship as stocks usually discount the economy, in this case housing stocks anticipating the housing industry. They can always catch up of course, which means that they should be monitored closely in the period ahead. Right now though, their action suggests a limited rally in starts.

Chart 5

The third window in Chart 6 shows that the RS line for the XHB has recently broken down from a double top formation and the RS KST is slightly negative. Since the KST for the absolute price, in the second window, is bullish, it would seem that the best we could hope for would be a rising ETF price, but given the weak relative action, one which rallies at a slower pace than the overall market. Should that prove to be the case, then we would expect to see this resurgence in housing starts to be relatively short lived.

Chart 6

Housing conclusion

The housing starts data has broken out to the upside and that suggests further gains for that industry, and given its leading tendencies, the economy as a whole. At this point housing starts seem impervious to rising rates, but the weak relative action of housing construction stocks combined with their less than stellar absolute price action, suggests a fairly limited horizon for both the ETF price and housing starts themselves. The two things to watch are the ratio between starts and bonds and an outcome from the XHB and ITB trading ranges.

Small cap big profits?

While housing may not look to be that inspiring as an equity sector, the small cap sector has started to break out in a big way both on an absolute and relative basis. We can see this from Chart 7, where such action has also been supported by decisive KST action.

Chart 7

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.