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Choose Your Intellectual Expert

The good thing about having two major bubbles within 6 years of each other is that if you have a memory, you may be able to apply the memories of the first bubble to the second bubble. It is with this premise that I would like to discuss some thoughts about today’s housing bubble as they relate to the 2000 stock market bubble. The most important fact to recall from the stock market bubble is that its duration was sufficient to render all fundamentally correct “early bird bubble callers” as either fools, driveling idiots, or worse. Those investing their money on the short side of stocks in the late ‘90s lost their collective shirt in addition to being outcast for their views. As was said many times in the late 1990’s and 2000, “they just didn’t get it.” The particular vivid memory that I recall is when the lone bearish “elf” on Wall Street Week, Gail Dudak, was relieved of her duties as an “elf” by Louis Rukeyser. In the late 1990’s brokerage house guests on CNBC wondered out loud whether Warren Buffett had lost his touch. Similar behavior is likely to occur in the US housing bubble.

Will Robert Shiller be criticized for calling a housing bubble? If the 2000 tech bubble is any indication of his timing, maybe not. The first edition of his book, Irrational Exuberance, was on book shelves in Mid-March of 2000. The recently released 2nd edition discusses the housing bubble and has been on store shelves for several months so far. In the game of “Choose Your Intellectual Expert,” Professor Shiller is batting 1,000 in calling bubbles (1 for 1). By contrast, Fed Chairman Alan Greenspan is batting zero (0 for 1). With regard to the possibility of a US housing bubble Shiller suggests that there is such a bubble, and Greenspan says it’s just “a little froth.” OK folks, it's time to “Choose Your Intellectual Expert”!

Beginning in the New Year of 2000, there was “capitulating buying” in technology stocks. With most non-tech stock market investments doing poorly by that time, the New Year brought many resolutions from those determined to finally give up on their blue chip stocks and finally “invest” in technology stocks. “Just get me in” was heard on brokerage phones all over the world. This final capitulating buying produced the Nasdaq’s final climax run to over 5,000. It seems quite possible that with real estate values going parabolic, people will hit the same panic button and capitulate with a final round of buying of homes similar to what occurred in 2000 for tech stocks. 

A catalyst for this final chapter in the housing bubble could come in the form of movement to higher mortgage rates which could provide the final cry from marginal buyers to, “Just get me in because tomorrow higher interest rates may price me out of the market.” Note that increases in interest rates preceded the final climax run in technology stocks in 2000, as well as in stocks in 1929. In 2000 the general feeling was that technology stocks were immune from the effects that higher interest rates would have on the “old economy.” In 1929, speculators were so enamored with the short term paper gains they were achieving in stocks, that higher interest rates for call money (used to buy stocks on margin) were negligible compared to the high double digit gains thought to be possible in common stocks. In the final phase of bubbles, the remedy to prevent a bubble from occurring in the first place has the opposite effect when it is used too late. In the manner that higher interest rates were ineffective in pricking the 2000 technology bubble, and actually catalyzed the final parabolic phase of the 1929 bubble, if interest rates move higher soon, it may catalyze a final blowoff phase of the US housing bubble. Falling interest rates may slow the housing bubble, as the buying may exhaust itself from the demand side. Of course exhausting demand wouldn’t help house prices very much either and it is likely that eventually the housing bubble would deflate from its own weight. If 2000 is any indication, the Fed is preparing to deal with the aftermath of the bubble and not the bubble itself. In the case of Mr. Greenspan, the Plan is to retire in January.

While it is not a useful timing tool, looking at insider selling can be an enlightening experience, especially when the airwaves seem to be saturated with discussions of the US housing market and homebuilders. It seems that a day doesn’t go by where the face of a homebuilder CEO or CFO doesn’t grace the stage at CNBC. They are all saying bullish things. But what are they doing? It seems that many corporate insiders are selling their company shares like they are going out of style. Of the 14 major homebuilders listed in the chart below there are only 9 where insiders presently own more than 10% of the company. Two of best performing homebuilders, NVR Homes and Toll Brothers, have seen insiders sell over $700 million in stock over the last 6 months. That’s a lot of “wealth management” and “portfolio balancing.” It is notable that the underperforming homebuilder, Dominion Homes, has experienced significant insider buying over the last 6 months, and it is the only homebuilder that has not seen any insider selling.

For Sale by Owner!

Two Year Trading Range

The US stock indices have been fairly quiet over the last couple of weeks. At times such as these it is worth while to focus on the longer term. The charts below present weekly charts of some major indices during the approximately 2-year trading range.

S&P 500

The most significant feature of the S&P 500 chart is the series of lower highs which were broken in late October of 2004, then became a support line in April of this year. The S&P is challenging its March highs, but as I draft this on Wednesday evening, it is losing its volume boost.

The S&P seems to be following a fairly regular weekly cycle lasting about 1 quarter per cycle. If this one year trend is still in place, the current cycle may be nearing its end, and we are due for a correction to a quarterly low. However, this is nothing to get too excited about until confirmed by the action itself.

A look at the 6-month daily chart shows that the short term line in the sand is at S&P 1220, with volume looking tepid and daily candlesticks looking painful. Yet confirmation of a bearish trend has not occurred, and we are in an Investors Business Daily (IBD) “confirmed rally.” Lagging the hot guru has proven to be expensive.

Mid-Caps

The leading market capitalization group in the latest rally has been the S&P mid-caps, which have already exceeded their March highs and are leading the market in relative strength. Is this bullish for the entire market? Perhaps not.

The chart below depicts the S&P mid-caps before and after the top of the technology bubble showing that the relative price strength of the mid-caps made a high at the top of the Nasdaq technology bubble. One can not rule out similar behavior in the stock market.

Nasdaq

The Nasdaq is approaching the psychologically important 2100 level. If it breaks it decisively, this will have bullish implications for the entire stock market. While last week, it appeared that the Nasdaq had begun to lag the S&P in relative performance, this may have turned out to be a whipsaw for now.

In past articles I described the importance of the behavior of “bellwether” stocks such as Cisco. Note how Cisco held the trading range bottom at about 17.5 with the help of a bullish Barron’s article. I think that it is no accident that with Cisco at the top of its trading range (20) Wednesday after hours, Cramer screamed for his disciples to buy Cisco, Microsoft and technology stocks in general. Cramer was screaming and sweating like a pig too! He’s shouting, for a “Cramer Tech Rally.”  This boosted Cisco to barely beyond its trading range in after hours trading; and if this gain holds and breaks decisively over 20 on Wednesday, the stock is likely to make it to about 22.5. This, of course, would be bullish for the entire Nasdaq and stock market.

In summary, the current rally is looking tired and overbought, yet the rally could resume if S&P 1220 and Nasdaq 2100 are taken out decisively to the upside. (More in “Today’s Market”, below.)

Today’s Market – a Potential Turning Point

All of the indices were down significantly today with the Dow Transportation and Industrials leading the way. It was the first decisive distribution day since mid-May. As you can see from the chart below, the S&P 500 was turned down from the March 1229 level, and the 1220 level which it tickled for the last week.

The Dow Transportation Index put in a loss of 111 points and produced a decisive ugly red candlestick which crashed through both its 200- and 50-day moving averages. By ugly red candlestick, the index opened on its high, and closed on its low. This suggests sellers overpowering buyers throughout the day. In terms of the transportation index, the rally off of the April low is but a memory now.

The Nasdaq outperformed the indices that are tethered to reality; but one would have to consider there was a Jim Kramer upgrade of tech stocks yesterday, which is discussed above. In any case the action on the Nasdaq today was anything but constructive, as it failed at the 2100 level on decisively high volume, and engulfed 5 days of trading as indicated in the chart below.

The market leading mid-caps are now at a key technical level. The index closed below its March high, albeit not decisively. Whether the 125 level holds in this currently leading sector will likely shed light on the near term future of the stock market in general.

In summary, the stock market may have seen a key turning point today from bullish to bearish. This observation would be negated if the Nasdaq closed above 2100 or the S&P closed above 1220. Whether the S&P mid-cap ETF holds 125 is a key for the stock market’s future direction. In my view, the weight of evidence favors the bears largely because the Transportation Index has been failing for several weeks and appears to be continuing a head and shoulders reversal pattern. Its most liquid leader, Federal Express (FDX), has broken a key support level on high volume today.

Gold was up today, as was the dollar. Let’s see what the HUI can do now that it is bucking up against an intermediate term trendline.

While it appears that the 10-year note is going up (interest rates down), the 10-year has not broken its interest rate low made a couple of weeks ago. In spite of well-publicized opinions of experts, a rally in interest rates would not surprise me in the least. It is at a key former resistance, current support point, where it’s near term behavior may determine its longer term trend.

Final Note

Last week was a particularly dead week for e-mails, and I’m thinking that the reason is the uneventful market conditions over the last four weeks. Not that I have a lot of time to answer e-mail, but sometimes it's nice to know that these missives are read, so do not hesitate to bring me your comments – critical or not. Is there anyone out there?

Have a great evening!

Martin Goldberg

Copyright © 2005 All rights reserved. Martin F. Goldberg, MS, P.E. Market Analyst Expert Page Commentary Archive Email

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