Outside Day Reversals and the Return of the Housing Market

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The Dow Jones Industrial Average tumbled 168 points yesterday to 12,058. But the Blue Chip index did not merely tumble; it sustained “technical damage,” according to the folks who place credence in stock price charts.

Yesterday’s selloff featured a textbook “outside day reversal,” in which the Dow pushed above the prior day’s highest levels, but then reversed and closed below the prior day’s lowest levels. This is bearish price action…and no stock market technician would deny it. The S&P 500 Index, along with almost every other US and foreign equity index produced similarly grim reversal patterns. The “risk on” trade is coming off very quickly.

On the other side of the ledger, gold soared to a new all-time high, while silver jumped to a new three-decade high. Treasury bonds also rallied – pushing yields down to their lowest levels in a month.

The stated reason for the palpable fear in the financial markets is the palpable fear in the streets of Tripoli.

As stated reasons go, this one is better than most. After all, the oil price is surging as a result of the Libyan chaos…and that’s definitely not a helpful economic phenomenon. But the real reason that stock prices are falling is “just because.” The US stock market spent the last four or five months rising for no good reason. So why couldn’t it also fall for no good reason?

If, in the midst of falling for no good reason, a really good reason happens to present itself, the selloff could gain momentum until, eventually, the stock market would be falling for no reason whatsoever. But we’re not there yet. The current selloff is long overdue, if not also amply justified… So we would expect the selloff to continue for a while yet.

One good reason why the stock market might fall further than most folks expect is that the Libyan crisis is not just a Libyan crisis. “Saudi Arabia’s Tadawul All Share Index tumbled 6.8%, the most since November 2008,” the Associated Press reported yesterday, “as concern deepened that political unrest in the Middle East may spread to the kingdom.”

Maybe there’s more to this story than meets the Western eye. Just maybe, a revolution in motion tends to stay in motion…and just maybe, a series of revolutions in the Middle East is not bullish for American stocks.

But your editors did not show up for work today to kick the stock market while it is down. (We already spilled enough ink kicking the thing while it was up). Instead, being contrarians to the core, we will turn our backs to the selling on Wall Street to examine a potential buying opportunity on Main Street.

The potential buying opportunity is called “a house.”

We are beginning to wonder whether residential housing has become a good investment once again…or, at least, a less bad investment than, say, an S&P 500 Index fund.

Throughout the bursting of the late, great housing bubble, your California editor continuously aired his gloomy observations and grim forecasts. Early in 2005, he became terrified of the housing market, both for himself personally and for the US economy in general.

In May of that year, he strolled into a CNBC studio to participate in an on-air debate entitled, “Bubble: Fact or Fiction?” The CEO of the National Association of Home Builders (NAHB) argued the “fiction” side of the debate. Your editor argued the “fact” side. The NAHB’s CEO, Jerry Howard, never deviated from the party line. The housing market is just fine, he insisted.

Summarizing Mr. Howard’s contribution to this CNBC debate, the NAHB website stated:

“Jerry went head-to-head with Eric Fry, author of the investment column known as ‘The Rude Awakening,’ on the network’s Power Lunch program…Jerry emphasized the solid fundamentals of housing, including low inventories, strong household formations and other demographic factors. Host Bill Griffeth was compelled to agree that ‘We are seeing legitimate reasons for this market to continue to be hot right now.’…As for markets where prices have outstripped incomes, Jerry cited a recent FDIC report that downplays the risk of a bubble bursting. Instead, says the FDIC, price growth will tend to flatten or slow for a while until incomes can catch up.”

Unfortunately, Mr. Howard’s forecast did not pan out. Instead, the residential housing market began to implode shortly after Mr. Howard and your editor unhooked their microphones and stepped away from the CNBC cameras.

But now that the housing market has been busting for almost six years, it may be less of a “sell” than it was in 2005. In fact, the housing market might just be a “buy.” We aren’t certain about that, but we are willing to consider the possibility…very willing.

Regards,

Eric J. Fry
For Daily Reckoning Australia

Eric J. Fry
Eric J. Fry has been a specialist in international equities since the early 1980s. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short- selling. Mr. Fry launched the sometimes-abrasive, mostly entertaining and always insightful Rude Awakening.
Eric J. Fry

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