Erik McCurdy's  Instablog

Today, the National Association of Realtors (NAR) reported an increase in existing home sales in April to an annualized rate of 4.62 million, meeting consensus expectations.

Total existing-home sales, which are completed transactions that include single-family homes, townhomes, condominiums and co-ops, increased 3.4 percent to a seasonally adjusted annual rate of 4.62 million in April from a downwardly revised 4.47 million in March, and are 10.0 percent higher than the 4.20 million-unit level in April 2011.

Total housing inventory at the end of April rose 9.5 percent to 2.54 million existing homes available for sale, a seasonal increase which represents a 6.6-month supply at the current sales pace, up from a 6.2-month supply in March. Listed inventory is 20.6 percent below a year ago when there was a 9.1-month supply; the record for unsold inventory was 4.04 million in July 2007.

The following graph from Calculated Risk displays the long-term view of the existing home sales trend. Early this year, we observed that the housing market had begun to exhibit early signs of bottoming behavior and the consolidation formation in existing home sales that followed the bubble implosion continues to develop as expected.

 

 

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The choppy downtrend in existing home inventory that began in 2007 continues to move lower, approaching 2002 levels.

 

 

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As a result, the months-of-supply metric has returned to an area that is typically associated with a "healthy" market near the 6-month level.

 

 

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During the summer of 2006, our analysis indicated that the top of the housing market was likely in place and we predicted several years of financial market turmoil as the most speculative real estate bubble in US history imploded. The initial phase of the secular decline in housing prices has proceeded exactly as expected since then and it has now been more than five years since the market turned down. Although this last bubble was unprecedented with respect to the speculative excesses that were introduced into the system, the ten-year housing cycle has been very reliable historically, so we expected the next bottom to form in late 2011 or early 2012.

Although real housing values have yet to form a confirmed bottom, we are seeing bottoming behavior in the data trends that usually precede the development of a low in prices. The following graph from Calculated Risk displays the long-term views of single-family home starts, new home sales and residential investment.

 

 

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Notice that all three trends have been consolidating at current levels since 2010 following the violent declines from 2007 to 2009. This behavior suggests that price is preparing to bottom as well, although it is important to note that the developing cyclical low will almost certainly be very different in character from all of the previous "normal" lows displayed on the graph above. Again, the last housing bubble was the largest, by far, in US history as shown on the following graph of real home prices from HousingStory.net.

 

 

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Home values will not rebound in typical fashion during the forthcoming cyclical uptrend. Instead, they will likely move sideways in a choppy consolidation formation as the market continues to integrate the massive oversupply introduced during the speculative frenzy of the bubble years. The healing process is underway, but it will take many years to repair the damage that was inflicted last decade.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

During the last three weeks, the S&P 500 index has declined 8.5 percent, retracing all of the gains since the middle of January.

 

 

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As usual, the violent drop was unforeseen by the consensus view. In March, the vast majority of mainstream analysts projected additional gains for stocks using common forecasting methodologies that rely on the Fed model and forward earnings estimates. Unfortunately, these techniques have a poor long-term performance history, especially near economic and market inflection points. Only a few analysts, such as fund manager John Hussman, had been warning that stocks were poised for a violent decline. The following chart from a recent weekly commentary at the Hussman Funds web site displays time periods during which the stock market has carried a comparable amount of risk during the last 30 years.

 

 

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Every time this high-risk syndrome has appeared since 1980, a violent decline has followed. For our part, in March, our computer models indicated that the risk/reward profile of the stock market had entered the worst one percentile of the past 80 years, suggesting that the outlook was poor from both long-term and short-term perspectives. The severe drop during the last three weeks is precisely the type of violent decline that we had been expecting.

As always, it is important to remember that there are no certainties when it comes to market forecasting. However, long-term success as a market participant does not require absolute certainty. If you are able to reliably identify the most likely possibilities, along with their approximate probabilities, your trades and investments will be consistently profitable. A strategy of aligning yourself with the most likely scenarios, while protecting yourself from the least likely ones, will invariably produce long-term success. The key, of course, is the accurate identification of those possibilities and probabilities. Most mainstream analysts simply assume those popular, simplistic methodologies are reliable and fail to perform the necessary due diligence before trusting in their validity.

Every forecasting technique should be back-tested with as much historical data as possible in order to gauge its statistical reliability. History does not repeat itself, but it certainly does rhyme due to the cyclical nature of economic development, so many market cycles should be analyzed when considering the relative merit of any given methodology. For example, the computer models that we use to measure the health of the secular and cyclical trends in the stock market analyze a large basket of fundamental, internal, technical and sentiment data. After these models were designed, they were tested using market data going back to the 1920s, covering five secular trends and 16 cyclical trends. The back-testing process indicated that our long-term market forecasting methodology was highly reliable, as it correctly predicted every change in the secular trend and more than 90 percent of the changes in the cyclical trend since 1929. More importantly, that historical reliability has translated into accurate predictions during the last ten years. At the beginning of 2008, when the mainstream view predicted a continuation of the bull market from 2003, our computer models signaled the highly likely start of a severe bear market. One year later, when the mainstream view foresaw additional losses following the market crash, our analysis suggested that we were on the verge of the best cyclical buying opportunity in a generation.

 

 

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Of course, it is much too early to conclude with a useful degree of statistical confidence that a new cyclical bear market is in progress, but it is important to note that the same mainstream methodologies that were forecasting additional strength in early 2008 and additional weakness in 2009 were predicting substantial additional gains in March of this year. Granted, it is certainly not easy to maintain a contrarian view at likely long-term inflection points. When many highly intelligent people insist that you are wrong, it is natural to question your beliefs and outlook. That is precisely why it is critical to base your forecasts on a highly reliable methodology that has been tested with as much historical data as possible. A time-tested, proven system enables you to focus on the important data and resist the emotional impulses that encourage you to join the crowd at the worst possible times.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

In early May, we noted that the US dollar index had entered an important short-term cycle that could have a meaningful impact on long-term direction. Since then, the dollar has moved sharply higher, approaching previous highs of the rally from August 2011.

 

 

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During the last four months, the overbought correction from January has developed into a bullish consolidation formation that favors a resumption of the intermediate-term uptrend.

 

 

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With respect to cycle analysis, the magnitude and duration of the alpha phase rally from late April has confirmed a transition to right translation.

 

 

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Price behavior during the next few weeks will likely provide a significant signal with respect to long-term direction, so it will be important to continue monitoring the dollar closely. We will identify the key developments as they occur in our daily market forecasts and signal notifications available to subscribers. Try our service for free.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.