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The Housing "Bottom" Is Now--Or Not   (October 18, 2006)


Various pundits such as entertainer Jim Cramer (you know, the "screaming head") have called the bottom in housing stocks. To see if they're right, let's ignore their rantings and look at some charts.



Although this chart is mine, frequent contributor Harun I. sent me a comment which explains the action in this chart very succinctly:
The housing index hit its 50% retracement level. At this level a bounce is expected but does not declare the bottom.

Cramer had Toll Brothers CEO on his show (I was flipping to PBS when I came across him). I won't bore you with an ad hominem rant on this individual but he and his followers may be in for a big surprise.

Toll Brothers stock has retraced 61.8% and should rally but no bottom is in evidence. The fact that there was no meaningful pause at 38.2% and 50% suggests weakness.
Briefly, here's what's going on in the housing index. Technical analysts have long noted that stocks tend to go up or down in stairstep-like patterns, and that these stairsteps often align with a Fibonacci series of numbers: .38, .50, .62, 1.0, 1.38, and so on.

Interestingly enough, the HGX is following an A-B-C-D pattern down and hitting Fibonacci retracement numbers. The analysis works like this: the move from 100 to the top at 280 is 180 points. A 50% retracement would be a drop of 90 points to 190, which is right where the index bounced.

The bounce target is 224, which is a 38% retrace of the 90-point move down. Interestingly, the HGX hit 221 before descending to 214 where it sits today. "Close enough for government work," as the saying goes. Hitting this target sets up the next ABCD downleg, as this chart shows:



Here we see the targets for the next stairstep down: 169 and then 100. (180 point move X .62 = 111, 280 - 111 = 169. 100% retracement = 280 - 180 = 100.) While screaming-head entertainers/pundits can call all the "bottoms" they want, even a cursory analysis of the HGX chart suggests the bottom is a long way down. Not shown on the chart is the third downleg, which will bring the index down to 50 or even lower.

Impossible, you say? Recall the dot-com meltdown, if you will. Take a real company such as Akamai (AKAM) which ran to $348 at the height of the dot-com mania in early 2000. It subsequently fell to 56 cents in October 2003. If the housing sector continues to build unwanted inventory and dumps that inventory for losses, why would anyone buy housing stocks? For the land, which is depreciating rapidly? For the book value of deteriorating assets?

I would say fair value of the housing index at the real bottom several years hence will be about 38. Give or take a few points; check back in October 2008 and we'll see where the index stands at that point.


For more on this subject and a wide array of other topics, please visit my weblog.

                                                           


copyright © 2006 Charles Hugh Smith. All rights reserved in all media.

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