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The S&P500 is down 17% since October, but it's up 7% in the last month. There is always the temptation to think we have entered a new long-term bull market run, and it's time to get long before it's too late. However, over the next 12 to 18 months, I believe the housing market will continue to be the fundamental driver of the US economy, and conditions in housing are still deteriorating.

First, let's examine some housing market facts. July housing starts data will be released on August 19, and if the trend remains intact we are headed downward. For example, last month's release showed single family starts declined at a rate of 5.3%, and this figure is down nearly 50% since January 2006. On August 26, we'll receive new home sales figures, which are also trending downward (down over 30% in the last year). Some bullish commentators will point to the inventory-months metric which seems to be bottoming around 10 months, but this can be misleading because it's based on a much smaller total amount of inventory and sales when compared to several years ago.

So why do we care about housing? A deteriorated housing market cripples the US economy in multiple ways. First, let's not forget that the hundreds of billions of dollars in write-downs by financial institutions have been caused almost entirely by deteriorating housing conditions, mainly securitized subprime mortgages, and many experts believe this figure could reach well over one trillion dollars before it's all over. Second, it's become almost cliché at this point, but tens of millions of Americans were using their home equity as credit cards, and now that home equity values have fallen, so too has the consumer's ability to spend. As home equity evaporated, consumers turned more heavily to actual credit cards, and the current record levels of credit card debt will drag on consumer spending and the US economy for quite some time to come.

Some bullish observers will point to the slowing rate of deterioration in housing as a sign of the bottom and better days ahead. I think this is a valid point, but even if we are bottoming in housing, I don't believe the recovery will be immediate. I understand the market is forward looking, but I have a hard time believing the subprime securities markets will return to their prior glory anytime soon. And even if housing is near a bottom, I just don't see home prices bouncing back to the levels of 2006 overnight (maybe I'm wrong, only time will tell).

Anyway, there are many tempting reasons to say the S&P 500 has bottomed and it's time to get long. For example, housing may be near a bottom, the US dollar has gained impressive momentum over the last month, ECB seems to be holding off on rate hikes, fed fund futures are forecasting lower chances of near term fed rate hikes, oil, commodity, and materials prices are finally bursting, and hard-core value investors are so excited about P/E ratios that they're foaming at the mouth. However, hard-hit home prices aren't going to increase 30 and 40% overnight, subprime mortgages aren't going to stop defaulting, consumers' credit card debt won't suddenly disappear, oil prices are still over $110 a barrel, the impacts of the economic stimulus checks are largely behind us, many experts are still predicting hundreds of US banks are going to fail, and you and I are going to pay (via taxes) to keep Freddie Mac and Fannie Mae afloat.

One month ago, I wrote about the increased likelihood of a bear market rally in the near term, and I believe that is exactly what we're experiencing as the S&P500 is up 7% in the last month. I certainly don't know when (or if) it's going to end, but I like to follow the VIX an estimator. The VIX is a stock market fear indicator which has bounced between 16 and 31-ish repeatedly over the last year. The last five times it broke 30 a bear market rally began, and when it gets down to around 17 the bear market rally ends (the VIX is currently around 20, and heading downward). If you believe the longer-term downward market trend of the last year remains intact (like I do), then we're closer to the end of a bear market rally than the beginning.

As always, no one can predict the future, and I am certainly not claiming to be able to. However, I still believe the market is headed downward due to the deteriorated housing market, and I have positioned my personal portfolio accordingly.

Source: Market Outlook: It's Still All About Housing