"Looks like we are done swimming for the day," my son said as the lifeguard put up two red flags to tell everyone the beach was closed. "Why did they close the beach?"
As we were walking back from the beach, I explained that the lifeguard had spotted a shark in the area. My son replied that lifeguards are one of the reasons he likes coming to the beach. "They can warn us when sharks are around."
This wasn't our normal routine, as we usually frequent an area of the beach with no lifeguards. This means a lot fewer people, affording us our own "private" beach, without the costs.
But, as my son pointed out, we take risks by not having a lifeguard around to tell us when danger is near.
Right now, consider me your lifeguard in this turbulent market, waving red flags to warn you that one section of our economy could be quite dangerous for investors…
The housing market.
Recent economic data from the housing sector have been waving warning signs, depicting a weak housing environment - one we can possibly even benefit from.
In order to see this weakness ahead of time, you have to pay close attention to leading economic indicators - those that contain actionable information by foreshadowing the housing market months or years in advance.
Right now, the housing market seems to be firing on all cylinders if you follow existing home sales data. March existing sales rose 5.1%. But then, this is a lagging indicator, pointing toward prior performance.
Leading indicators paint a completely different picture for the housing market, telling us that March's strength won't last long. And we can use this leading information to make one simple trade to take advantage of the situation.You Can Lead a House to Profit
Which leading indicators am I talking about? Building permits, housing starts and new-home sales are all waving red flags right now. In fact, only one leading indicator, pending home sales, is showing any positive signs … and those are slight at best, and worrisome at worse. But, we'll get to pending home sales in a minute…
While March existing-home sales rose, March building permits fell 8.6% to a one-year low, housing starts fell a greater-than-expected 8.8% to their lowest level since October, and new home sales fell for the third straight month.
If you have any money in real estate, these are worrying figures.
Why? With building permits and housing starts showing sluggish growth, we know it's likely going to be a rough year for homebuilders. What's more, with new-homes sales declining for three months in a row, we know that demand for newly constructed homes is sluggish as well, putting additional pressure on homebuilders to live up to expectations this year.
All of these data points speak to an American consumer who is discovering that buying a home is not as affordable as it once was. Whether student loan debt is holding them back or the lack of decent-paying jobs, the fact remains that consumers are not as anxious to go out and buy a brand new home.
Getting back to pending home sales…
The March report, which came out Wednesday, rose 1.4% from February, appearing to offer a ray of light for the housing sector. Yet, this leading indicator still showed signs of weakness, as sales in the western U.S. declined for the fourth time in the last five months, showing an unbalanced increase in pending sales.
It's also important to note that during this time last year, new-home sales were a leading indicator for pending home sales of existing homes. New-home sales tumbled in early 2015, much as they have so far in 2016, but pending home sales of existing homes rose in the same manner as we just saw in March. For the remainder of 2015, however, pending home sales of existing homes headed lower, and I expect things will play out in the same way this year. In short, the leading housing economic indicators are pointing toward rough times ahead, and here's how you can profit…Flipping Housing on Its Head
One easy way to benefit from the coming downfall in the housing market - without shorting a housing company - is to own an inverse exchange-traded fund (ETF). An inverse ETF essentially does the shorting on a sector for you, by tracking a broad list of stocks within that sector.
Since all the data I see point to trouble for homebuilders, we want an inverse housing sector ETF, such as the ProShares UltraShort Homebuilders & Supplies ETF (NYSEARCA:HBZ). This ETF aims to return twice the inverse daily performance of the Dow Jones U.S. Select Home Construction Index.
One downfall to using an inverse ETF is that, due to the strategies used to manage such funds, there may be times where the inverse ETF loses ground even when the underlying index is flat or even slightly negative. However, this is true for all ETFs, even bullish ones, and it's something you should be aware of.
Ultimately, I expect to see a bigger decline than just a few percentage points in the Dow Jones U.S. Select Home Construction Index. The index fell nearly 25% between December and February, though it has since recovered. During that time, the ProShares UltraShort Homebuilders & Supplies ETF rose nearly 55%, more than double the inverse return of the index.
Given the current readings from leading economic indicators on the housing sector, it's easy to see this scenario playing out again. Look to take profits once you are up more than 55%, and place a stop-loss there to manage your remaining position.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Chad is an investment analyst for The Sovereign Investor Daily, and is also editor of Pure Income, a newsletter that taps into the best off-the-radar opportunities for generating safe, steady monthly income.