US Homebuilding Stocks Gave Early Signal of Housing Top and Housing Bottom

THIS IS WHY WE FOLLOW CHARTS ... We've been treated to a lot of bullish news on the housing sector over the last month. Builders broke ground on more homes during October. Residential construction rose last month at the highest rate in more than four years. Permits for new construction were 30% higher than a year ago. An index of builder's confidence hit a six-year high earlier this month. It was reported this morning that the Case-Shiller Home Price Index rose 3% for the sixth straight monthly gain in a row. That index is the most widely-followed barometer of the health of the housing industry. It peaked during the middle of 2006 and bottomed during the first quarter of this year. The main reason why we follow price charts is because they are leading indicators of any industry's fundamentals. And, once again, the charts spotted the housing recovery a lot sooner. Chart 1 plots the Dow Jones US Home Construction Index since 2000. The homebuilding index peaked during 2005 (nearly a year before the Case-Shiller index) and broke its multi-year up trendline during 2006 (red circle). That was a clear signal at the time that the housing boom was over. It took the investment community until late 2007 to acknowledge that.

HOUSING INDEX GAVE MAJOR BUY SIGNAL LAST JUNE... Chart 1 shows the home construction index hitting bottom in late 2008/ early 2009. It achieved a successful retest of that low during the second half of 2011 before breaking its major down trendline during that fourth quarter (green circle). More importantly, the housing index cleared its 2010 high during June which completed a major basing pattern and signalled a major new uptrend (solid circle). I've been writing bullish comments on the housing industry since the fourth quarter of last year based on that bullish chart pattern. It took the economic community nearly a year to acknowledge the improvement. Homebuilders have, in fact, been the strongest sector of the market during 2012, and correctly signaled that the housing industry was in recovery. Once again, the charts were early and the economic community late. I can't wait to see all of the buy recommendations being issued by Wall Street in the coming weeks. Meantime, the construction index has more than doubled in price since the fourth quarter of last year. That's why we follow charts. And why we prefer the market messages being given by charts rather than economic messages which are usually way behind the market.

Source: John Murphy's commentary on StockCharts

The Foundation of Technical Analysis

Simply stated, Dorsey, Wright focuses on the “price” of a security, because it is the ultimate determinant of supply and demand in the marketplace. When you cut through all the red tape on Wall Street, what moves stock (and thus ETF) prices is supply and demand. It is nothing more than ECONOMICS 101. We know why tomatoes in the winter don’t taste very good, don’t have a very long shelf life, and are expensive. The same forces that move prices in the supermarket move the stock market. When it’s all said and done, if there are more buyers than sellers willing to sell, the price will move higher. If there are more sellers than buyers willing to buy, the price will move lower. Therefore, recording the price action of a security can yield important information as to who is winning the battle for that security — supply or demand.

Source: Tom Dorsey about Dorsey, Wright & Associates

S&P500 Potential Downtrend Target

The S&P 500 is in a long-term uptrend on this chart and there were two sharp corrections in 2010 and 2011 (17% and 19.7%). A similar correction (18%) would carry the index to the low 1200s. There is, however, a higher support zone around 1300. The spring lows and channel trend line mark support here.

Source: Stockcharts