Justin Lahart has an excellent column in today’s WSJ on a subject near and dear to our hearts: Misusing the stock market as a forecastging mechanism:
"Investors who trusted in the magical powers of the stock market to forecast a recovery in housing have been finding out what can come of trusting in fairy tales.
Less than two months ago, the idea that the housing market was at a turning point, and that shares of home builders were a screaming buy, was firmly established. In early February, the Dow Jones Wilshire U.S. Home Construction Index of home-builder stocks was 39% above its July 2006 low point. Since then, it has tumbled 21%."
We discussed this very same subject last week: EMH (Part 3): The Home Builders:
"What’s been even worse, we continue to see people reaching all
manners of ill-advised conclusions from the shorter duration charts of
various flavors and sectors; these have the unfortunate tendency to
lead the faithful astray. In the past, we have advised to "Beware Economists seeking guidance from stock markets;" the very same meme applies to traders and strategists drawing bold conclusions from very short term charts also.Which leads us to some recent charts. Let’s take a look at the Home
Builders: Its amazing that some people claim to read charts, yet
manage to draw the precisely wrong conclusions from them. Remember,
since no one knows the future, all investing and trading are games of
probabilities regarding any given possible outcome. We cannot expect
perfection — but we can at least hope to see some measure of
intellectually defendable theories. All too often, even that modest
goal is missed.A classic example of this misunderstanding has been the action in
the Homebuilders over the past few years . . ."
In Lahart’s column, he looks askance at the circular nature of a certain type of equity market analysis:
"How did investors come to believe housing was getting better in the first place? One possibility is that the rebound in home-builder stocks tempted them into seeing signs of improvement that weren’t really there. While there is a certain allure to the idea that stocks, which move on the real-money decisions of thousands of investors, are better at predicting the future than any forecaster, this sort of thinking can be dangerously circular: Home-builder stocks are going up, therefore housing is getting better and therefore it is time to buy home-builder stocks."
In other words, you should not believe that sector momentum is necessarily telling you anything other than the fact that there is momentum in a that sector.
The same can be said about markets in general. In the past, we have also taken economists to task for this bugaboo (Beware Economists seeking guidance from stock markets). We have also been critical of the blind faith some place in prediction markets for the very same reason.
This isn’t to say that the market’s ability to discount various outcomes isn’t a valid tool; The inverted yield curve, major trend breaks, market sector leadership all provide clues as to the probabilities of likely future outcomes. Indeed, there are dozens of internal data points which provide various measures of clarity as to future probabilities.
But blind reliance on the markets as a magical forecastor of the future? Thats placing religon over science. Its track record is only as good as the collective reasoning of the crowd, as logical as a pack of hormonal teenagers, as wise as a mob of soccer holligans.
Markets are only marginally better than its components: skittish, irrational,dangerous-in-crowds, susceptible to emotions human beings. While they may remove some of the noise, they also manage to provide evidence of the precisely wrong conclusion at exacvtly the worst possible time.
Some will incorrectly take this criticism of markets forecasting accuracy as proof that your humble author believes he is smarter than the market. Indeed, the last time out we criticized this school of thought, we were taken to task by for our "arrogance and hubris" for believing markets occasionally get things wrong. It is worth noting that those critics were long the homebuilders, and have since been carried out on their shields.
Mr. Market is at times a Rorschach test, a blank slate upon which participants project their hopes and fears. He reveals the personality characteristics and emotional functioning of investors by their interpretations of the noise he generates. Remember this the next time you are tempted to create a grand theory of what happens next based only upon a few of his recent squiggles . . .
>
Sources:
EMH (Part 3): The Home Builders
TBP
Tuesday, March 13, 2007 | 06:16 AM
http://bigpicture.typepad.com/comments/2007/03/emh_part_3_the_.html
Believing In House of Cards Haunts Investors
Justin Lahart
WSJ, March 19, 2007; Page C1
http://online.wsj.com/article/SB117426469866641020.html
BTW, congrats to Calculated Risk for the prominent mention in the article
http://calculatedrisk.blogspot.com/
Calculated Risk (the blog) has been red-hot on the issue of mortgages during the last week. Some excellent info on Wells, on the exotic-mortgage issues (different than the subprime issues)… read back a few days, especially the posts by Tanta and the comments.
There is a momentum in markets and a momentum within the industries supporting the markets.
Strange but human, the industry’s momentum seems more prevalent than the supporting markets.
This may be, why none of them are offering reliable forward guidance.
A thought on housing:
In previous poor times for housing the important marginal buyers where first-time buyers who made a down payment and took out a fixed-rate loan. If the market was risky they would still jump in because having some equity and a fixed rate loan lowered that risk. Also, if we go back 20 years or more people lived longer in their houses so they thought of their house even more as a long-term buy. We are all investors now – but it wasn’t always like that.
Today’s marginal buyers are/were more likely to put little down and take out a riskier loan. They also are more likely to view a house or apartment as something that they will sell at some point.
If these assumptions are correct, then it seems obvious to me that today’s marginal buyers will be much more hesitant to buy in a falling market than pretty much at any non-recession time in history. How many twenty-something first-time buyers with median salaries do you know who can and will put 20% down and take out a fixed rate morgage today? How many of the same group do you know who are reckless enough to jump into a falling market with no money down and a interest-only morgage and can actually get that morgage say six months from now?
Which is why we could get the biggest drop in history unless first-time buyers jump in with complete recklessness. Recklessness of course is what has kept America above water for a couple of decades, but I have never seen a more likely scenario of this unsustainability coming to an end than what we see now in this slow-motion (so far) slow-down.
Michael said: “How many twenty-something first-time buyers with median salaries do you know …? How many of the same group do you know who are reckless enough…?”
Was that just a gigantic rhetorical flourish, or what? Unless you’re a grad school professor (or a manager at Best Buy?), I doubt that very many people know tons of twenty-somethings, much less their real estate-buying proclivities.
Good Post, Barry.
I’m in in total agreement.
I’m a twenty something (26 to be exact). I have very few friends who are buying homes or are inclined to buy homes. I have spent a lot of time counseling my friends on what they can afford or what to expect with home ownership. I have been suprised at how little a lot of them know (“you mean I would have to fix that?”). Also with valuations so high a lot of my friends can’t qualify when their other debt is added into the situation (if they want something other than the I/O, ARMS or whatever pos the bank comes up with).
Now, some of the twenty somethings are alright and are buying houses but they usually have wealthy parents or they had full rides through school aka no student loan or credit card debt.
The idea of young people entering into greater home purchases is a myth. There are fewer homeowners relatively today than there were in 1980 for every age demographic under 55.
Homeownership Rates by Age Group
2000(1980)
15-24: 17.9 (22.1)
25-34: 45.6 (51.6)
35-44: 66.2 (71.2)
45-54: 74.9 (77.0)
55-64: 79.8 (77.6)
65+: 78.1 (70.1)
http://www.fanniemaefoundation.org/programs/census_notes_8.html
Speaking of housing, yet another “downside dud” of a report hitting the tape, this time the NAHB index …
* The overall index dropped to 36 from 40 a month earlier. That was below the 38 reading expected by economists.
* All three sub-indices dropped. The index measuring present single family sales dropped to 37 from 40, the index measuring expectations for future sales dipped to 50 from 53, and the index measuring prospective buyer traffic fell to 28 from 29.
* Regionally, the biggest drop was in the South (-4 points). The Midwest and West saw 1-point gains, while the Northeast saw a 2-point dip.
At the risk of sounding like a broken record, we’ve just received another batch of disappointing housing stats. It’s clear that the small housing rebound seen in late 2006 is fading fast under the weight of excessive inventories, rising mortgage delinquencies and foreclosures, slumping home prices, and tightening credit standards. Indeed, the NAHB figures just put an exclamation point on my forecast that the 2007 spring selling season will fall flat.
http://interestrateroundup.blogspot.com/2007/03/nahb-index-slumping-again.html
housing market in my area (upper midwest) is a lot better than last year at this time. single family inventory down 20%. Too many condo’s going up though it seems to me.
Barringo,
You ought go get the latest Roubini and post the whole thing here.
—
Let me say something to you, Nouriel (if you’re listening), you sweetheart savage, you. That latest piece is a universal and cumulative piece of unadulterated poetry if I’ve even seen any.
It’s complete, passionate, correct, direct, indicting, compelling, condemning, insightful, delightful, and to sum it it up… it’s a splendid piece of clipped English, multi-syllabized, Roubini-istic, tangible excellence, with the possible exception of your lightening up on the GSEs, for which I give them little slack.
Accordingly, Nouriel, I have decided to prounounce your latest writ as worthy of a named Epistle, and we shall canonize your work heretofore to be called the “Second Epistle to the Kudlownians,” and that’s annotated: “II Kudlownians,” and booked in canon along with that somewhat subdued but equally eloquent “I Kudlownians” already sermonized widely by Dr. Benber N. Anke, himself in the flesh.
Good work and I salute you.
-Eclectic
I have heard what so far is rumor that Iran on March 21 will make it illegal for anyone in Iran to hold or trade in U.S. dollars, and that North Korea and Malaysia have followed suit. As Japan is the biggest oil trader with Iran, what will the BoJ do with all those dollars if this rumor is true? If the BoJ slows their subsidization of GSE paper with their bond purchases, where will mortgage rates go but up?