See What Real Estate Reveals about Stocks

As the 2006 third-quarterearnings report seasongot under way, newsfrom the housing sectorcouldn't have beenworse. The nation's largest builder,D.R. Horton, warned that fourth-quarterearnings would be 25% lowerthan the previous year, cancellationshad risen to 40%, and orders weredown 43%. D.R. Horton's report followedthe same trends as a number ofthe nation's largest builders.

Zolton Pozsar of Moody's Economy.com recently predicted that up to500,000 jobs could be lost in housingover the next 18 to 24 months.

Wall Street Journal

Not only has housing become a largerpart of the economy since 2000, itrepresents a bigger part of householdwealth. In a article inSeptember titled "Full House," economistsDr. Robert Shiller and Dr. KarlCase stated that US household realestate holdings were valued at just under$8 trillion, or 40% of household wealth,10 years ago. That figure had more thandoubled to $21.6 trillion, or 56% ofhousehold wealth, by year-end 2005.

The National Association of HomeBuilders Housing MarketIndex (NAHB HMI) isbased on a survey of morethan 400 homebuildersacross the country andmeasures home sales andmarket expectations forthe next 6 months. A readingbelow 50 is consideredbearish. In September,the NAHB HMI fell10% to 30, cutting theindex by more than halffrom a reading of 65 inSeptember 2005. Thismeans builders are morebearish on the housingmarket than at any timesince 1991.

What does this mean for the economy?Merrill Lynch economist DavidRosenberg recently compared the NAHBHMI with the S&P 500 Index and founda striking 80% correlation between thetwo. It is, he says, "a relationship thatover time has actually strengthened,owing to the growing influence that thereal estate market has exerted on theoverall economic and financial landscapeover the past 5 years."

In this monthly chart, the S&P 500(blue) vs the NAHB HMI (red) showsthe growing correlation between them,which lagged 12 months.

As a leading indicator of the stockmarket, the NAHB HMI is saying thatthe S&P 500 is headed for a lower lowthan that which occurred in October2002 when the index hit 777. In fact,assuming this correlation between thetwo continues, it would mean anS&P 500 value of approximately530 by thefall of 2007.

Maybe real estate willrecover and with it theprognosis for stocks. Butbased on the NAHB HMIas a leading indicator,investors should be prepared,at the very least,for the possibility of anS&P 500 bear market inthe upcoming months,especially in late 2007.Considering that the yieldcurve is bearish and hasremained inverted formuch of the time sinceJune 2006 (ie, long-termbond yields below short-term yields),this is not a possibility that you andyour portfolio can afford to ignore.

Matt Blackman is host for Electionomics.com, a Web site that examines theimpact of government policy on markets. Heis a senior market analyst for TradingEducation.com. A technical trader, publishedauthor, reviewer, and keynote speaker, Matt is a member ofthe Market Technicians Association and TechnicalSecurities Analysts Association. He can be reached atTradingEducation.com/contact.