The Trend Of Housing And NYSE Margin Debt Both Reverse To The Downside

• Housing Starts are Rolling Over
• The Trend of Margin Debt is Bearish

The NYSE Margin and the housing sector do not have much in common beyond the fact that both gave sell signals in October. Neither development bodes well for the recovery of the stock market. Let’s take a look at housing first.

Housing Starts are Rolling Over

Housing start data is an important number, in spite of the fact that the housing industry doesn't forms a large part of the economy. It’s important due to the fact that the economy is really nothing more than a set series of chronological events; turning points in housing are a key benchmark in this regard. The first thing that happens during a recession is a drop in interest rates, which, after a lag, feeds back in a positive way to the economy. The first thing that you can actually touch and feel is the highly sensitive housing sector, in the form of housing starts. When housing begins to pick up, it represents an early bird signal that the overall economy has started to respond to improving financial conditions. It’s the first green shoot signaling that a recovery is around the corner. It also works in reverse as the economy matures, mainly due to the fact that housing is usually the first area to respond to rising rates. That adverse response to rising rates is what  appears to be happening now.

Since starts are notoriously volatile I have plotted them as a 4-month MA in Chart 1. Note how peaks in the KST typically line up with those for housing starts. Usually, such action is followed by a bear market in housing, though that was not the case in 1994 and 1999 where sideways patterns developed. Since its peak in 2013, the KST has been slowly zig-zagging lower and has dropped below its MA once again. This seems like a valid signal because the housing start MA has also violated its 2013-18 uptrend line.

Chart 1

Chart 2 compares housing starts to new homes sold. As a rule, the two series move reasonably closely together, but the trend of new homes sold has gone bearish. That’s because it is below its 24-month MA and the bull market trend line. Additionally, the KST has peaked, all of which suggests that new home sales are headed lower. Since builders are less inclined to start new projects when sales are slowing, housing starts are likely to move lower as well.

Chart 2

Chart 3 compares starts with the ratio between new home sales and houses still left on the chopping block. The red arrows show that this sales/inventory ratio typically leads housing starts by many months. The reason lies in the fact that homebuilders eventually respond to a backing-up of inventory by building less houses. The ratio peaked way back in 2013, well ahead of the early 2018 top in starts. Now it is falling sharply, which means that inventories are expanding pretty quickly. Often in the past, a steep drop in the ratio has translated into a sharp drop in starts. That does not necessarily have to be the case in this instance, as housing went through a generational crisis in the last cycle and the kind of mistakes that caused it are not usually repeated so quickly. Nevertheless, the message pertaining to some form of decline in housing starts is still valid.

Chart 3

Obviously, this is not the best news for the homebuilding stocks. Chart 4 compares the Philadelphia Housing Index to the new home sales/inventory ratio. The arrows point out the fact that the ratio has a strong tendency to lead home-building equities at both bottoms and tops. The completion of the 2012-18 top in the ratio is therefore not a good sign. The good news lies in the fact that these equities are oversold on a short-term basis. Consequently, while lower prices are ultimately likely, there will probably be a better opportunity to sell them between now and year-end.

Chart 4

The Trend of Margin Debt is Bearish

The trend of NYSE margin debt is important for two reasons. First, a rising trend means more money is flowing into equities, which is bullish. Second, it also means that investors are confident enough to take on more risk in the form of the extra debt; that kind of growing confidence typically translates into higher prices. A declining trend in margin debt is bearish for the opposite reasons.

Chart 5

In the last few months, the level of margin debt has been in a tight trading range. October, however, saw it take a sharp decline from $648 billion to $607 billion. That drop was sufficient to result in a violation of the 2009-18 bull market trend line and the 12-month MA. In addition, it generated a KST sell signal. I should note that the 12-month MA cross is not that reliable, but the trend line violation is much more significant. Following the two previous examples of this combination, the S&P experienced a primary bear market.

Another way of analyzing margin debt is to compare it to GDP. That way, we can get a better fix on its relative importance to the size of the economy. That relationship is shown in the center window of Chart 6. Two things stand out. First, this ratio has also violated its bull market trend line and triggered a KST sell signal. Second, it was recently at a record level, indicating a very favorable sentiment towards equities. That proved to be short-lived, as the ratio has now fallen back below the red horizontal trend line, thus indicating that the breakout was a whipsaw. Often, whipsaws are followed by above-average moves in the opposite direction.

Chart 6

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.