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September 14, 2006

Is the Real Estate Bubble Really Deflated?
by Clif Droke

To hear the news media talk the death of the real estate bull market is a foregone conclusion. There is, after all, a near unanimity among news publications of all stripes - including those that are known as being permanently bullish on stocks and real estate - that the real estate bubble is in the process of deflating with no hope of a comeback in the foreseeable future.

Everywhere one turns, it seems, one can't help hearing about the demise of the real estate bubble. This topic of discussion has made quite a resurgence in recent weeks as evidenced by the number of times the term "housing slowdown" has been mentioned in recent Internet blog posts or chat boards.

For instance, CNNMoney.com recently published an article entitled "Deflating the real estate bubble." It said, "Forget all those predictions about a soft landing..." From there we're told the real estate deflation isn't over yet and we could be in for a long winter, so to speak.

As if that's not enough we're constantly bombarded with the latest housing construction statistics, the most recent of which showed that construction spending plunged to its largest decline in five years in July. This was "seen reflecting housing weakness," according to one news wire report. Also declining in the most recent reporting period was builder confidence as, according to the Commerce Department, "a record backlog of unsold homes has forced many builders to offer an array of incentives to reduce supplies."

The famous luxury homebuilder Toll Brothers added fuel to the fears of a massive real estate decline when it recently reported a sharp fall in its quarterly profits. Toll said that Americans have markedly reduced their purchases of luxury homes in the past year. Toll reported a third quarter profit decline of 19 percent which Toll's CEO, Robert Toll, blamed on an excess supply of houses and a "lack of appetite by buyers who purchase homes as investments."

"The continuing malaise in the housing market...is the result of oversupply of inventory and a decline in confidence," he said. "The speculative buyers of 2004 and 2005 are now sellers."

Forbes recently published an article asking the question, "How low will real estate go?" ("The boom is over, now the arguing is about how long lean times will last.") Whenever any mainstream media publication asks the question "how low will it go?" in reference to any financial asset you can rest assured the worst has most likely been seen. We'll talk about this a bit later in this commentary. But first a glimpse at what the pundits had to say in the Forbes article.

"The boom is definitely over, there's no debate about that," according to Mark Zandi of Moody's Economy.com. "Now the question is more how hard it is going to land, if it lands at all." I would respectfully beg to differ with Mr. Zandi as we'll see from the market's number one leading indicator. Suffice it to say there's enough evidence from a psychological as well as a cyclical standpoint to allow for a real estate recovery in 2007.

Yet in spite of all this talk of the real estate slowdown, it's interesting to note that it hasn't yet been confirmed in the real estate equities (REITs). The Dow Jones Real Estate Index (DJR) as of Wednesday, Sept. 13, has even made a fresh new high for the year at 288.69. Not only is this a high for the year-to-date, it's also an all-time high! So if real estate is in such bad shape how come the single most sensitive leading indicator/barometer for the overall internal health of the U.S. real estate market, namely the REITs, have held up so well until now? Is this a rare case of the physical real estate market peaking out and leading the real estate equities downward? Or could it be that the real estate slowdown is about to end and an in increase in housing activity will begin anew in 2007?

For those of you who read my book "America's Housing Bubble" you know that this latter possible explanation is the one I most favor. As I explained in the book, this year's 8-year cycle was expected to bring down the general level of housing sales and real estate activity on both a commercial and residential level, which it has. But now that the 8-year cycle is bottoming I'm willing to venture that by early next year we'll see those real estate statistics that look so bad right now take a turn for the better. That seems to be the message of the Dow Jones REIT Index (DJR).

As evidence that real estate equities haven't yet finished their bull market, I refer you to the series of internal momentum indicators for the REITs known as REITMO. These short- and intermediate-term internal momentum indicators for the REITs (which are based on the number of real estate stocks making new highs versus new lows) were are all decisively sending a positive momentum signal and suggest the REITs have even higher to go in the months ahead. Most importantly, the 60-day internal momentum indicator for the REITs started surging upward in the second half of August and has been going higher each day ever since. One thing I've learned from following the internal momentum indicators this year is that even if all the other short-term indicators are down, if the 30-day and/or the 60-day indicators are still rising and making higher highs there's always an excellent chance that the sector in question will go on to make higher highs as well. This has certainly proven to be true for the REIT sector as the 60-day momentum indicator is positively soaring! Even the 5/10/20-day and 30-day indicators have turned up since late August and have made higher highs even as the real estate stocks rally into an admittedly "overbought" position.

So with the bullish message screaming loud and clear from the real estate equities, the latest talk of a deflated real estate bubble seems premature indeed. Here are a couple of areas to watch as having further boom potential in the months ahead:

* Southeastern coastal real estate will continue to boom . Each day nearly 2,000 people migrate to the Southeast and to the Gulf Coastal areas of the U.S. as the Baby Boomer generation heads toward retirement and will flock to the East Coast in droves to settle down.

* San Diego and Phoenix markets, among other western regions, may still have a ways to go in their respective slowdowns but watch for a comeback in Washington, D.C., metro area real estate next year.

Clif Droke
ClifDroke.com

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy. The forecasts are made using a unique proprietary blend of analytical methods involving internal momentum and moving average systems, as well as securities lending trends. He is also the author of numerous books, including "How to Read Chart Patterns for Greater Profits." For more information visit www.clifdroke.com.

Copyright © 2003-2008 Clif Droke

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