Everything Old is New Again! Raymond James analyst Rick Murray said, "Homebuilding stocks are currently trading at about 1.2 times book value, which is far above where valuations have troughed in past cycles. During the housing crash of the late 1980s and early 1990s, valuations fell to 0.6 times book value."
Home construction did in fact fall 9.8% last quarter, the biggest decline since 1995, yet consumer spending, which is 65% of the economy, rose 5% over last month. This is another pin in the Consolation Prize Theory, and another indicator that things may not be as dire as they seem.
What else happened in 1995? Here is a chart from Jan 1993 to Sept 1994 when the housing boom of the early 90s was coming to an end:
Notice how Toll Brothers (NYSE:TOL) was a typical builder at the time; they had a great run (all the way to $5 a share!), and fell off a cliff that spring:
Look familiar? Yep, it's almost exactly like TOL's current chart (only the current one is x 10)!
So what about the S&P you may ask? Cue eerie music and reveal... THE SAME CHART:
This cannot be you say! History cannot repeat itself to such an extent. Surely the commodity run we are now having is unique...
Here is Phelps Dodge (PD) 1993-5:
And here is PD 2004-6:
Newmont Mining (NYSE:NEM) '94:
Nope, apparently we've been there and done that too. How about the majors?
Coca Cola (NYSE:KO) '94:
Boeing Airlines (NYSE:BA) '94:
Caterpillar (NYSE:CAT) '94:
You get the idea. So everything old is new again.
Will the housing slowdown kill the economy? Everything in 1995 looked pretty overbought and primed for a crash; home inventories were out of control and the Fed was just winding down a loose money cycle that had dropped prime rates from 10% in 1990 all the way down to 6% in 1992, where it remained until March of 1994.
From March of 1994 through Feb of 1995 the Fed, determined to put the brakes on the housing market, raised rates 3% in just 6 moves, driving prime all the way to 9% in the summer of 1995. Rates remained between 8% and 9% through Jan of 2000.
Well, that certainly sounds like a recipe for disaster doesn't it? Runaway commodity pricing, home builders collapsing, high rates...
What did the S&P do? We can see how the markets looked ready to fail in September of 1995 as the Fed had clearly over-tightened by driving the discount rate to up 5.25% and the GDP had plunged to 2.5%. After 18 months of rate-hikes, the Fed did decide to take a pause at their July meeting (they didn't meet so often back then), and recession fears took over the market by September.
As you can see on the S&P chart, between Sept 1st and Oct 5th, the S&P lost 6% and things looked pretty grim, but perspective can be a wonderful thing — look how the picture changes as the panic subsides and we move into the new year:
That's a nice 50% gain!
I've been saying for a long time that we need some healthy consolidation in order to make new levels, and that is exactly what happened in 1994 (also a mid-term election year).
It is possible that Bernanke, obviously a student of history, learned his lesson and timed his pause a little better than Greenspan did in 1995 (don't forget rates were still going up through February '95 on the 1994 charts), but we are not going to bet the farm on it.
Like I always say: If it's a REAL rally, we're not going to miss much by being skeptical at the beginning!
While it would be nice to avoid the pain and just move higher, a failure to make our technicals at this point (almost exactly the same point as we were at in 1994) should make us very cautious in the short term, but I'm excited about the potential to go bargain hunting this winter in case history repeats itself!
What happened to the homebuilders? Well, I'm sorry to say that they rallied too as it turns out a rebounding economy burns off excess inventory pretty quickly.