Every person I’ve ever talked with about the stock market has his or her own little talismans (indicators) for stock market ups and downs. The fact that this is a presidential election year doesn’t count in this article, because housing sales seems to be taking a front seat in a lot of investors’ minds. But, like any other indicator, housing sales has its ups and downs and pockets that defy the usual predictability. In some cases, the recovery from foreclosures and “walk-aways” might be slow, and other factors can make using housing sales as a stock market indicator a moot issue.
One good thing about depending upon housing sales as an indicator for the stock market is that plenty of information exists to help determine how things are going nationally. Every fourth week of the month, the National Association of Realtors (NAR) releases the Existing Home Sales Reports and then the New Home Sales Reports. They derive their information for the existing home sales report from the previous month’s reports, focusing on the average sales prices in various regions within the country -- West, South, Midwest, and Northeast. Three different factors are being considered when creating the report. These include the monthly supply or inventory level, the median selling price, and the price of properties sold, as well as the figure representing the amount of time needed to get rid of the entire remaining inventory within the period.
Then there are the “housing starts” reports, which are quite different than the existing home sales reports. Officially known as the New Residential Construction Report, this monthly document is designed by the U.S. Census Bureau along with the U.S. Department of Housing and Urban Development (HUD). The data for this report is derived from surveys of homebuilders nationwide, and three metrics (housing starts, building permits, and housing completions) comprise the statistics.
The reason that investors often use numbers from these reports varies, but they all seem to indicate growth. Growth often indicates a recovering or stable economy. But, there is a slight difference in the numbers contained in the NAR reports as opposed to the housing starts reports:
- Existing and new home numbers, if high, may indicate that existing home values could fall in upcoming months to help reduce inventory and to bring the housing market into a more stable environment. And, while low numbers of existing and new homes might indicate a booming economy, that information often comes out too late to prove a great indicator for the stock market.
- Housing starts and building permits, on the other hand, are both considered widely to be leading indicators. The Conference Board uses building permit numbers in their U.S. Leading Index, as construction growth usually picks up at the beginning of a business cycle. This means that building permits, especially, are used to identify these business cycle patterns in the economy. A large number of building permits means that business is booming somewhere...these numbers also are regional, so be aware of that fact.
Even the Federal Open Market Committee uses building permit numbers during their policy meetings. That committee is part of the Federal Reserve, which means that building permits play a part in the federal funds rate. Changes in the federal funds rate trigger a chain of events that affect other rates, including short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services.
So, now that it seems clear that building permit numbers comprise the key leading indicator for the housing market as it influences the stock market. This doesn’t mean that new and existing home sales reports are moot – using all the reports together can provide a clearer picture of what’s happening to the business cycle across the nation. And, having those stats in your paws rather than depending upon media hype is very important if you use these numbers for your own research.
But, you might also include a weather report or two in that mix, because weather is a huge factor for building permit numbers. Think tornadoes, earthquakes, and all the other natural disasters I talked about in the previous article. The more numerous the disasters, the more numerous the building permits, right? Not necessarily – the replacement of an existing home alters those figures. This misfortune puts a little kink in the data, so economists often present those numbers as seasonally adjusted and smoothed using statistical formulas.
You have plenty of time to mess around with those building permit statistics, though -- according to the Census Bureau, "it may take four months to establish an underlying trend for building permit authorizations, five months for total starts, and six months for total completions.” This means that building permit numbers provide more time to mull over the impact they might have on the stock market, let alone on mortgage rates, long- and short-term interest rates, credit, and the prices of goods and services.
Right about now I can feel that your eyes are glazing over. This use of housing starts as a key indicator for the stock market can be difficult, and I haven’t even folded the rental component of the Consumer Price Index into this recipe. Additionally, all this information provides just one aspect to a very complex market. It’s like fishing for trout with a worm, when you really need a lure (hoping the guys will appreciate that analogy).
Using the housing market (specifically building permits) when you’re a long-term investor means only one thing…that you have time on your hands, and might breathe easier about your holdings if the numbers are good. At the same time, using an overall approach with the Dow or Nasdaq, can shave time from your research and may prove even better indicators for how markets are faring. But, then again, this is an election year, so all bets are off.
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