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Lumber Leading Housing Index Lower

08/19/11 09:10:31 AM
by Mike Carr, CMT

A longstanding correlation between lumber and home builder stocks points to lower prices for the builders.

Security:   HGX
Position:   Sell

Home construction requires a large amount of lumber, so a relationship between home builders and lumber prices seems to make sense. As shown in Figure 1, the price of lumber tends to lead the home builder stocks at turning points. Home builders are represented by the Philadelphia Housing Index, which includes companies like KB Homes and Ryland.

FIGURE 1: $HGX, WEEKLY. Lumber has turned before the home builders at each significant trend reversal in the past few years.
Graphic provided by: Trade Navigator.
Home builders also show a strong correlation with home prices, another intuitively obvious relationship. Residential real estate has been in a bear market on the national level for the last few years. According to the widely followed Standard & Poor's/Case Shiller index of home prices, the market has fallen more than 30% since peaking in summer 2006.

The relationship between supply and demand applies in the real estate market just as it does in any other freely traded market. In the past, home prices have risen when the supply of new homes shrinks. Figure 2 shows that supply of unsold new homes is still higher than average.

FIGURE 2: US SUPPLY OF HOMES, MONTHLY. With more than a six-month supply of new homes available, a bull market in housing prices is unlikely.
Graphic provided by: Trade Navigator.
If home prices will be stagnant to lower, as the inventory of new homes supports, then home builders are likely to see slow, if any, earnings growth. Lumber prices points toward a decline for that sector, and the weight of the evidence approach to technical analysis on economic data supports that conclusion.

Mike Carr, CMT

Mike Carr, CMT, is a member of the Market Technicians Association, and editor of the MTA's newsletter, Technically Speaking. He is also the author of "Smarter Investing in Any Economy: The Definitive Guide to Relative Strength Investing," and "Conquering the Divide: How to Use Economic Indicators to Catch Stock Market Trends."

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