The biggest driver of our economy historically has been real estate.  In the past, consumers used their homes as piggy banks, cashing out funds as their values rose.  We all know that the bursting of the real estate bubble is what brought our financial system to the brink of disaster.  I believe we are still close to the 'edge of the abyss', in spite of what our government says.  As I pointed out a couple of days ago, the bond market is suggesting that Fed manipulation of the money supply could careen out of control should they continue to try and hold rates down.

At any rate, the PHLX Housing Index (HGX) has moved lock step with the S&P 500 most of the time.  When it diverges, there is trouble on the horizon.  Notice in the chart below how the housing index hit its all time peak in the summer of 2005.  At that time there was a frenzy of relaxed loan standards, with many banks and mortgage companies following the Countrywide model of simply writing the mortgages with no regard for the facts.  That type of bubble mentality takes time to work through the system, which was evident by the S&P continuing on for two more years before the bubble finally burst.  Take a look at October 2007 and you can see that as equities topped, HGX was already in a firmly established downtrend. 

Now fast forward to today - you can see that HGX moved higher with the S&P off of the March low, making higher highs through this past summer.  HGX is lagging which is not good news for the overall economy or for equities.  Some may argue that this divergence can go on for a couple of years as it did in the past, but I believe it is 'different this time', to coin a popular phrase.  Since last December, the Fed has injected trillions into the economy to keep it afloat.  That activity compressed everything into a much smaller time window that will unwind in a much smaller time frame than when natural market forces have the S&P the inertia to continue higher even when cracks were evident.  Given the fact that the government continues to support key industries while unemployment remains near all time highs, this is not our average garden variety recession.  The housing market is saying that the government initiatives are running out of steam, and the bond market will tell us when the party is over.





Happy New Year!