Forecast and overview for Q2 2003
Cliff Droke
Another financial quarter is in the record books and a new one has begun. The debate among analysts as to what the second quarter will hold has been fierce with strong evidence from both the bull and bear camps to back up their assertions.
I'd like for use to step back for a moment and let the charts speak for themselves as to what the second quarter of '03 may bring. We'll examine the two most critical areas of the economy under the microscope of the charts along with the key moving averages and then we can decide what the near future is likely to bring. I believe the conclusions, in most market segments reviewed here, are fairly obvious and any straight-minded person should be able to figure out from the following evidence what is
likely to happen using these key indicators.
Real Estate
Let's start with the housing sector, the first of the two critical leading indicators for the economy. Just how big is the real estate "bubble"? Pretty big by most accounts. But there is some question as to whether the real estate market, which is still humming, has seen its peak in terms of *price* relative to volume of sales. You've probably read something of this in a series of articles posted recently on some well-known financial web sites. Regardless of whether or not sales prices have peaked is inconsequential; what matters is that volumes are still quite brisk and are actually increasing in some quarters of the housing
market.
The real estate bubble (if you will permit me to use that term) is really a product of clever advertisement on the part of the real estate industry. Mortgages are being pushed the way Internet stocks were touted a few years ago. Advertisements for low-interest loans for big ticket items, including housing, are just as common as credit card promotionals used to be. It has always amazed me that the great salesmen of this nation have always been able to capitalize on interest rates in a big way. For instance, when interest rates are high the banks are able to bring in lots of money from the public by advertising savings accounts and CDs. When abnormally low (as they are now) then real estate and auto loans are touted. Either way, the banks win and someone stands to make a lot of money. Such is the case with the present low-interest situation in regard to the real estate
market.
Many analysts have recently gone on record as stating that real estate as "topped." I myself fell victim to this line of thinking about a year earlier during the recession of last year. But the market has forced me to change my line of thinking in this matter. As to when the real estate bubble will ultimately peak is anyone's guess, but I estimate it could last another 1-2 years before prices begin the declining phase in earnest. Before expanding on this, let's take a look at the leading benchmark for real estate equities, the Morgan Stanley REIT index (RMS). This is a leading indicator for the overall real estate sector.
Here's a fact worth pointing out about RMS: for the 8 or so years this index has been in existence the 100-day/200-day moving averages have been in a bullish configuration (i.e., 100-day MA above 200-day MA, both averages rising) for close to 5 of those 8 years. The averages got out of their bullish alignment in mid-2002 and have been unaligned ever since, but as you can
see from the above chart the 100-day MA is threatening to penetrate back above the 200-day MA, which would send a bullish signal. This would put RMS in line to challenge its previous peak of approximately 470 (RMS currently near 450). And what would such a bullish signal spell out for the broad U.S. real estate market? Obviously that the bull market in housing isn't over just yet. This alone could keep the economy propped up for a while longer.
So why do I believe the real estate bubble won't pop this year? Because the final, blow-off portion of the bubble hasn't even begun yet. This occurs when the last of the long-term holdouts from the general public, people who have been renting all this time, begin earnestly buying property and taking out huge loans to buy or build housing.
Also, another indication that I've found particularly useful is when the Fed Chairman openly makes a statement about the bubble (whether real estate, stocks, commodities, or whatever it happens to be at the time) and proclaims his "concern" over the high prices and excessive speculation (remember "Irrational Exuberance" in 1996?) When this happens it does not signify a top; rather, it signals that the most dynamic portion of the bull market, the final upswing, has just started. This can last anywhere from 1-3 years from the time the Fed officially expresses concern, but rarely less than one year. It hasn't been more than a month or two since Alan Greenspan expressed his sentiments about the U.S. real estate bubble, therefore we should have at least the remainder of this year with the real estate bull market intact.
Another indicator I use for determining the time left in a bubble is what I call the "existing potential indicator." Runaway speculative bubbles cannot end until they suck in every last dollar from the available sources and they rarely leave any stone unturned. We all know from the laws of physics that "nature hates a vacuum." Applied to the real estate market, developers and
potential home buyers hate to see unused land go to waste. Whenever you drive down a highway near a commercial or large residential area and see unused, undeveloped land that could easily be developed, you have to believe that the land will be clear-cut and developed before this bull market ends. Failing to develop these lands would be lost potential in the eyes of the
developers and lenders, and "lost potential" isn't in their vocabulary during such times as these. Whenever you drive down a coastal or other desirable area and see vacant lots or undeveloped property, these "vacuums" MUST be filled before the real estate bull market can end, simply because there is fast money to be made and a rip-roaring bull market has a way of bringing everyone out from the woodwork, even the long-term hold-outs. It's already happening at a rapid pace, but there is still some potential for further development...which leads me to the inescapable conclusion that this bull still has legs.
Stocks
Would you believe that the benchmark S&P 500 index is close to giving a signal that hasn't occurred in over four years? The signal I'm referring to? The crossing over of the 100-day moving average above the 200-day MA as the S&P is coming off a major low. These two averages are key for following the interim trends since they reflect the dominant interim cycle and its
half-component (i.e., the 20-week and 40-week cycles), which govern the dominant forces behind the stock market in the intermediate-term. Every time since the bear market began the S&P has tested the 100-day/200-day MAs it has failed to penetrated above them and has been turned back to make lower lows. But this time the S&P has a legitimate shot at finally
making the upside penetration. Take a look at the S&P chart below and you'll see just how close this signal is to happening.
Would a bullish crossover signal mean that the 3-year-old equities bear market has ended? In view of the longer-term cycles, no. In fact, the bear market should actually intensify in 2004 and beyond. But a bullish crossover signal from the 100-day/200-day MAs would at least signal a quarterly upturn that could last until summer. In any case we must be prepared to
act on such a signal if it occurs.
But even if this crossover doesn't happen a strong argument can at least be made for a quarterly bottom having occurred between March 10-12, when the Dow Jones Industrial Average tested the 7400 major supporting floor without breaking it and when the ratio of downside-to-upside trading volume on March. 10 was 18:1. That ratio leaves little doubt that a dominant low is in since the historical measure for a bottom is an 11:1 or 13:1 ratio. A reading of 18:1 is way above this standard bottom gauge and is a powerful indication of mass capitulation (intermediate-term) and also a sign that the insiders are going to protect the Dow from falling above 7400 for now. There is simply too much at stake right now geo-politically for them to let the Dow collapse right now. Yet another indication that an important interim low is in is the fact that the 8-day run following the March low was the best
percentage gain since September 1896 (yes, 1896, not 1996)!
Conclusion
Based on the available evidence, it would seem that the second quarter will witness a respite from the harsh economic and trading conditions of recent months. The real estate bubble should continue and doesn't look like it's ready to pop quite yet. Stock prices may well see a tradable relief rally this spring, and at least should stay above the Q1 lows. It's now simply a matter of "wait and see" as we enter the early stages of Q2 2003.
April 4, 2003
Clif Droke is the editor of the weekly Bear Market Report, a combined forecast and analysis of U.S. stocks and indices and international precious metals stocks, and is the author of numerous books on finance and investing, including most recently "Gold Stock Trader's Almanac 2003." Visit his web site for free samples of his analysis at www.clifdroke.com
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