San Diego Housing Market News and Analysis

Powayseller asked...

"If Roubini is right, and the Fed cuts rates at its September meeting, thus fulfilling the mid-term election year political promise, could the stock market rally for one year? In spite of weak earnings and lower GDP and rising oil prices?"

Sure it could. Or it could not. Perhaps there is a chance to time the RE market, but I'd say there is absolutely no chance to time the stock market. At least, I know I can't do it (perhaps smarter traders can), so I'm not even trying.

By the way, one of my favorite blogs, www.crossingwallstreet.com, just had a piece on the stock market and election cycle. It's interesting reading, but I'd suggest not to draw too many practical conclusions out of it.

Chris Johnston
iamafuturestrader.com

This is one of the most widely known cycles in the stock market. I am not sure how anyone could look at something like this that has outperformed the market as a whole by this magnitude, and conclude that.

There are many people, myself included, that have track records of beating the market. These types of tools are what you use to do it. The reason why they do continue to work, and always will, is that the average person thinks their arbitrary opinion of the economic conditions at hand supercede cycles. What if your opinions are wrong? What if we do not have a big recession, and a big RE selloff?

As a result, they will kick this info aside and "wait until it is safe" to go in. March 2000 was the last "safe" time. The "safe" point they choose is typically where people like me are exiting (selling).If everyone acted properly in accordance with cycles like this, they would probably diminish in their effectiveness.

Timing RE is much harder due to having much less historical data, and also that nature of the asset and it's lack of liquidity. I do sense in here in general, a very obstinate nature in opinions. It is one thing to have strong opinions as most of us do, but what about considering the other side occasionally. I am constantly forced to do this due to the nature of my business. I have to maintain the flexibility in my thinking to admit to a trade being no good, and getting out of it. Often at times that can mean, completely reversing my position based on the facts at hand.

I share the same view many of you do about the fate of RE in the next few years. However, I will venture to bet that most of you will be afraid to buy when the bottom falls out for fear of it going further. I would argue, that will be the exact time you should buy. Waiting for it to be "safe" is not a way to get ahead of the herd.

In conclusion, what about just for the moment considering that the second most powerful stock market cycle that has provided a great timing edge for over 50 years, might actually have some value? Economists make money selling you opinions, not investment advice. Most of them cannot trade their way out of a paper bag, and wouldn't even try to. And to top this off, in the spirit of being flexible, I could be wrong! I am willing to take the loss if I am wrong and move on to the next high probability situation. There are no guarantees in life the last time I checked.

For me the time it is "safe" to go in, is when everybody is trying to get out, when prices are at the bottom. With real estate and stocks, I am looking for a bottom.

Although company earnings will increase only after consumer spending picks up again, it seems stock markets can rally in the face of declining earnings. That's how we end up with overvalued stock markets.

I did a little research today on the mid-election year cycles, and there truly is a historic precedent. This does not mean that company earnings are going up in Year 3 of the election cycle, but stock prices go up anyway. This counterintuitive fact threw me for a loop. I thought the stock market would rally only when earnings go up. But I guess not - it can rally when earnings are flat or declining. Perhaps Chris has more info on how often the stock market rallies in the face of declining earnings.

I expect the Fed to start cutting interest rates in September, and again in November. This could set the economic stage for a good rally. Nonetheless, history going back 60 years or so shows this is the best time for stocks - the fall of a mid-election year. You hold for one year, so it's a long term trade. Thanks again to Chris for pointing this out. I am anxious to follow this.

There is historical precedent for the markets to rally in mid-term presidential election years. Furthermore, "according to the Stock Trader's Almanac, all the net gains in the Dow Jones industrials since 1950 have occurred from November through April. On average, since 1914, the Dow has jumped a whopping 50 percent from the bottom it hits in the second year to the top in the third year, the Almanac says. This bounce ties in with statistics that show the second and third years of the four-year cycle tend to be the best for stock markets as the party in power gears up for the following year's election, and tries to keep investors happy. Barring unpredictable developments in Iraq or global oil supply, the analysts said, the market could see a similar move, down and then back up, later in 2006 and 2007. Money.cnn.com

WiseAdvisor:
"Fortunately, one of the most reliable and easily understood cycles is the 4 year election cycle. This is well documented going back several decades and it is dominated by the need to produce a strong economy a few months prior to the Presidential election. What this means is that starting 2 years prior to an election, policy needs to turn highly expansionary as there is about a one year lag before this policy feeds through to the economy. In other words 2007 needs to be a year of significant stimulus to ensure the economy feels good in 2008 well ahead of the election at the end of that year.

Hussman Funds
The 12-month period beginning in October of the second year of the presidential term has enjoyed average total returns of more than 28 percent, on average. And since 1933, not a single third year 12-month period beginning in October has registered a loss (the worst return was a gain of 6.6 percent).

Chris Johnston
iamafuturestrader.com

The simplest way to explain the earnings relationship is as follows. The market is anywhere from 6 months to a year ahead of the earnings. A rally now indicates future increased earnings, not current. A decline now indicates future decreased earnings not current. Earnings are not currently declining. Even the RE firms have increasing 12 month earnings right at this moment, just plot the numbers.

Homebuilder earnings are declining though. Consumer spending is slowing, and the slowing housing market and higher oil prices are weighing on the market, aren't they? I have not followed the stock market much the last few years. Could you explain then why you are in cash now - aren't you expecting a stock market decline, and then you want to get in at the bottom in time for the rally?

Here's an interesting chart, Long-Term Interest Rates going back to 1960. It is in response to someone who said we are at a permanently higher plateau with stock prices. When we were in a period of rising interest rates from 1960 - 1982, the S&P500 gained only 2.9% annually, while from 1982 - 2003, a time of falling interest rates, it gained 10.5%. It's never really different.

The other charts on that link above are very interesting - they show that slowing consumer spending presages bear markets, and corporate profits actually recover during a recession, while unemployment hits its highest level and people are afraid to be in stocks. It is precisely at that time, when the indicators appear so bad, that is the best time to be back in the market, getting ready for the next rally. So what retail analyst Elliott found in his research lines up with what Chris does in his trading. They are looking at the stock market from different angles, but finding the same thing.

I share the same view many of you do about the fate of RE in the next few years. However, I will venture to bet that most of you will be afraid to buy when the bottom falls out for fear of it going further.

Oh.

Here's another factor of support for a stock market rally: wages are rising. I am using Elliott's model for predicting bear and bull markets based on the leading indicator: changes in the RATE OF CHANGE in PCE, which is led by WAGES. With wages starting to go up, consumer spending ought to get a nice bounce.

Now the only question is, how much will the housing slowdown and high oil prices affect the consumer pocketbook and work against the #1 predictor of earnings per share (which is real wages).

Does anyone have any data for stock markets rallying in the face of declining earnings? I am certainly interested in a possible rally this fall, as I want to up my 5.5% return. Historically, there has been huge rallies buying into the mid-term presidential election years. Buying at that time and holding for 1 year gets 20-50% returns.

Chris Johnston
iamafuturestrader.com

All of the reasons why I went to cash in stocks are the reasons I explained in my newsletter the last 3 months. The seasonals, the commercials, and the bond market divergence. My plan all along was to exit in April/May and gear up for the fall rally. Seasonals do not always work right on the dime, but they do provide a good general framework to look for opportunities. The market has not yet fallen as far as I thought it would by now, so maybe it will not. I will just wait until the fall, and see if this trade is set up properly. If today were Nov 1st, it would not be a go due to the commercials not being heavily long at this point.

I have no idea if there is any correlation between consumer spending and stock rallies and declines. I have never studied that. It is tough to use government reports for study due to all of the revisions that occur over time with them.

Hi, I'm a post.

What I was wondering is how often stock market rallies occur in times of falling earnings. As corporate profits continue falling over the next 6 months, I was expecting the stock market to fall too. With the 4-year cycle scenario, the stock market would rally in the face of falling profits. So I'm wondering how often this happens (a stock market rally in the presence of falling corporate earnings), and if you have any time periods for this.

I guess a Fed easing could spark a rally, but how long-lived could that be, considering rising inflation and falling earnings?

I expect corporate earnings to be low for at least a year, and a stock market bottom in early Q1 07, when the recession starts. My plan is to get back into stocks when they are really beat up, early to mid next year.

This whole thing is very interesting. If the market doesn't rally this fall, would this be the first exception in the history of the market?

Chris -

Do you have a website? Do you charge for your newsletter? How would I be able to sign up for it?

Chris -

Do you have a website? Do you charge for your newsletter? How would I be able to sign up for it?

Chris Johnston
iamafuturestrader.com

SD my web site address is www.iamafuturestrader.com and I also have a blog that has a link to it from the bottom of the first page of my site. The link is in the midst of the last paragraph of text. The direct link is http://iamafuturestrader.blogspot.com/.

I cover something related to these types of things each day. Often I discuss commodities in the blog since so many people are interested in that nowadays.

The newsletter is a pay service that is $250/yr. If you send me an email to info [at] iamafuturestrader [dot] com I could send you a copy of one of the newsletters so that you could get a feel for what it typically covers. It may or may not be for you, depending on your interests. I do cover what I expect in the stock market upcoming in every edition, that is one of the basic staples of it. Typically I will also cover other markets that are either in the news like GOLD or Oil, or one that is set up for an upcoming trade.

I love Chris' newsletters! In one of them, he showed his research, via charts, of why gold does not follow the dollar, but inflation. It was driving me nuts when the median would keep writing "gold is up today because the dollar is weaker", when that was just a coincidence. The media people have no clue why things happen, but they feel like they must give a reason for why they do happen. They're just making stuff up. But Chris' stuff is based on research and his experience trading for 20 some years.

Chris, are you still looking into that question: examples of where the stock market rallied when earnings per share were decreasing.

Chris Johnston
iamafuturestrader.com

Strictly by the rules of this cycle, it is a 2 year hold. That does not guarantee that is starts right on the dime in the fall. We just know from history that the fall represent s the best buying time window. As we put all of the pieces together in constructing an investment or trade, we want to have all the best pieces. I showed the difference between buying stocks in July and exiting in November vs. buying them in November and exiting in May in the newsletter last month. That just by itself shows the difference timing can make.

I will not hold the stocks for 2 years. Years ending in 7 (2007) are notorious for intra year sharp declines, so I will want to dodge that if I can. I do recall finding one year that was very close to a scratch trade with this cyclical pattern, but I do not have that info in front of me right now.

The one comment about earnings that I would make is as follows. They are not dropping yet, you are assuming they will and you may or may not be right. For trading purposes and research, we can only view historically what they were doing at the time of an entry into a trade. We cannot factor in what we thought they would do in the future. There is no way to project back in time and know what our opinion might have been at a specific point in time, as to what earnings would do in the future.

Right now earnings are not dropping, so history would show for example that a trade entered on 8/15/06 was done during a period of increasing earnings. That chart I sent you (poway) on Lennar showed the uptrend in their earnings over the last 12 months. Even though we all expect that to change, currently their earnings as reported are still good.
As a result research into Lennar stock trading in relation to earnings done today would have to feature increasing last 12 month earnings as a variable.

Hope I did not get too technical with this.

Years ending in 7 (2007) are notorious for intra year sharp declines, so I will want to dodge that if I can.

Did you read that on Yahoo! Astrology?

There is no way to project back in time and know what our opinion might have been at a specific point in time, as to what earnings would do in the future.

You haven't seen Back to the Future?

Chris, do you have a spot on your site that shows you performance for more than a 3 year window and profit % rather than % winning trades?

Ok, let me ask it this way: are there any times you can think of, where the stock market rallied during or just before, a period of falling earnings. A rally could occur during declining earnings based on perhaps the Fed lowering, oil prices falling, a Mideast conflict easing.

I believe earnings will keep falling into next year, until the imbalances in our economy are worked out. Consumer debt must stabilize, and consumers have to either save or get the ability to take on new debt. Until then, the economy will keep slowing. However, if the Fed cuts interest rates in the fall, and we can have a rally. How that rally could sustain for 2 years is beyond me though.

I am looking to get into stocks next year, when earnings are very low, the builders/retailers/banks are hammered due to bankruptcies and foreclosures, and nobody wants to own stocks. That's when I would get back in.

Your mid-year election cycle plan has historical precedent, but runs counter to what is in the pipeline for the economy. So it requires the stock market to rally in the face of declining earnings.

Chris Johnston
iamafuturestrader.com

Anx - I am not sure why you try and antagonize me, I do not believe I have ever done anything to warrant this. These things I mention are commonly known things in the fund management world. The sharp mid year corrections in years ending in 7 historically is there, just look at a stock chart of the DOW back to 1900. It is of the utmost importance to be aware of large scale cycles when you are a market timer like I am. They do not always repeat in exact fashion.

As far as the track record on my site. That just reflects the actual results of the system that is featured in the daily trading service, which was created and put into play in Feb of 2004. I have other systems that I use that are not on the site with longer track records. The % return depends on an individuals money management style.

I risk anywhere from 5 to 20% of my accounts on any one individual trade which can make the return percentages very high in good years. 2004 was a triple digit year, 2005 was in the high 70's percentage wise, and this year it is at approximately 33% YTD(the system has not done as well this year as the last two so far).

You could also figure returns based on the margin of a bond contract which is $2000, however, that makes the return percentage disproportionally high and hence is misleading. Also, a trader should have his margin in T-bills yielding 5% at all times, which also adds to the return, but is not part of trading results.

As a result of all of this, it is hard to state a specific return percentage. I have entered an international trading contest with this system this year, which will provide an actual return % for a full year utilizing all of the trades from the daily trading service. That is the best way I could show a return for someone to see, in an independently audited fashion. I was in first place at one point, and have currently slipped out of the top 3. They only list the top 3, so I do not know where I stand exactly. I only know that the return is currently at 33%, the guy in third is at 44% currently.

At one point I was up 61% and then the system took a couple of losses. I hope this answers your question.

Chris Johnston
iamafuturestrader.com

Poway, I would say that this trade is not for you to worry about. I probably should have never mentioned this as it has become a can of worms.

All of those discretionary things you mention are not part of the rules for this trade, so I have no idea what influence they would have. None of those things you mention are part of the setup for this trade. I showed you in the newsletter two months ago that lack of correlation between stock and oil prices. I am not sure how much more definitively it could be proved than what I presented.

There have been many stock rallies during periods of declining earnings historically. I am a rule based trader, if something is not part of the rules for a trade I do not care what it is saying. The rules are based on years and years of research, and finding repititive patterns in the markets. I trust in my research and tune out all the noise.

The 30 yr has already rallied a good amount, enough to support a stock rally. Let's just forget about this and go back to bickering about RE. The OC numbers for July just came out and our incredibly ugly, the bulls are really going to struggle spinning these numbers. This fall is really going to be interesting in RE.

Chris, your input and experience have been very valuable. My questions are to improve my understanding of the markets. People ask me questions all the time. Look at the objections I am getting over at the months inventory post. I think it is fair for people to question what I am saying; if my system is really that good, I will be able to answer the questions; if I cannot answer the doubters, maybe my system is not that good after all and needs to be modified.

In my opinion, we are heading into a long period of declining earnings later this year, which will bring on a bear market lasting for at least one year. I prepared for this in March 2006, by going 95% cash.

Then, I hear about a very interesting mid-presidential election year rally, which has never missed since the 1930s. Your theory is not anything that needs defending; it is a well known stock market cycle.

I am trying to reconcile the economic slowdown we are heading into, with a historic precedent for a rally in the late fall. I was hoping you could explain how this could happen, and if it happened before.

It's my understanding that your trading system uses a variety of proprietary trading inputs, but not economic forecasts. You look at the bond yields, technical trading indicators, COT report, and various other things. Is the COT report a proxy for the economy? I assume the COTs go long when they perceive corporate earnings will rise in the near future.

Since you don't use economic input, you wouldn't have tracked earnings per share and probably don't have the data on whether the stock market rallied while earnings decline. But I wonder if the COT report ever showed they were short, and the market rallied anyway. In your trading system, is there a proxy for the economy or do you trade on technical signals alone?

The question posed by anxvariety, about your historical returns is certainly fair. Some of the considerations you use, like not being in the market in years ending in 7, do sound unusual, so it does make one curious. Often a system works well during a bull market or a bear market, or a time of rising commodities (Zeal), but then the system no longer works when economic conditions change. How well will Zeal do when commodity prices retreat?

Also, I am not sure how my question relates to stock and oil prices. Your detailed review of 4 studies showed that oil prices do not affect the stock market, but I think it's safe to say that earnings, inflation, and the Federal funds rate definitely affect the stock market. Inflation may stop rising and the Fed may lower interest rates, but I'm certain earnings will fall. So the question was: how can the stock market rally when earnings are declining?

I asked Bill Fleckenstein if he expects a rally this fall, in the mid-year cycle. He said

"I do not pay attention to cycles, but I don't expect a rally this fall-- just the opposite."

I told him that in 1982 and 1990, both recession years, the stock market rallied after and during the recesson. He said

"1982 and 1990 are different from today"

This is just his opinion, and he could be wrong...

One more thing: Barry Ritholtz wrote today that the stock market ralied because core PPI came in low. But the rally will be short lived. PPI fell because low demand for light trucks forced discounts, so truck prices fell. Everything else in the PPI index rose, and rose by a lot. Some materials costs rose over 4%! In an ironic twist, GMs stock rose because demand for its trucks is down.

Chris Johnston
iamafuturestrader.com

You mentioned oil in your post, that is why I responded to it. Price changes in oil do not effect stock price swings at all from my research.

If you just read my website sections on discretionary trading you will understand why I do not bother with all of these other arbitrary things. I in no way represent that my way is the only way to go, only that it is what I do.

For those who want to synthesize these massive amounts of data collectively, and come to a decision of when to buy and sell, I will leave this thought. Most managers do not beat the S&P 500 each year, and many of them have very powerful people in research staffs doing exactly the same thing. That is very tough competition, yet beating them does not even assure you of beating the averages.

You have to learn to look at things differently from the herd to get ahead. My way is one way of doing that, and there are others.

Please, let's just move on. We are comparing completely different approaches to investing, and we will never resolve this.

The Coming Economic Collapse, by Stephen Leeb, PhD

"When we examined the relationship between oil prices and these zigs and zags [recessions and periods of strong growth between 1973 and 2000], we discovered that economic downturns and bear markets were always preceded by rising oil prices In particular, whenever the price of oil doubled over a 12 month period, stock returns ranged from -27% to +4% over the following 18 months. On the other hand, whenever oil prices declined over a 12 month period, stocks returned anywhere from -1% to +30%."

According to the book jacket, Stephen Leeb "edits the prestigious newsletter The Complete Investor. Renowned for consistently finishing among the leaders in the annual stock-picking contests of the Wall Street Journal and Forbes, he is the author of 5 previous books and holds a BA in economics, MS in mathematics, and a PhD in psychology."

In the book, he explains that the media, government, and Wall Street is short sighted in not recognizing the oil shortage, and recommends investments that will outperform as inflation and energy costs rise.

Chris, the studies in your newsletter about a relationship between oil and stock prices are pretty short term. 3 of the studies looked at the effect of a change in oil prices on the stock performance the following day. The one study which looked at 12 - 67 day moving averages, found a mild connection. Investors consider the price of oil to be volatile, and therefore don't base stock decisions on the movement of daily changes in the oil price. Rising oil prices are a problem for the stock market only when they are persistent, because then they are inflationary. A 1 week rise in oil prices doesn't mean anything. Now with this logic, the past 2 years, where oil prices have been steadily rising, should be bad for earnings, and thus, stocks. The Fed has been raising rates for 2 years, and stocks have held up pretty well. So the mitigating factor is the global liqudity.

You and I have very different approaches to investing. My approach is based on the economy, yours on technical signals. I think when both approaches line up, there should be a much higher certainty of a win. But if you do not wish to discuss this any further, I will oblige.