Monday, May 05, 2008

Is Pessimism Extreme Enough to Mark a Housing Bottom? No.

Frequent contributor Harun I. recently posed this question: has the housing market reached the point of "maximum pessimism"? If not, then it isn't the bottom.

Today's post ( More on Catching the Bottom in Housing) was excellent as usual.

My gauge for spotting bottoms is far less sophisticated. The principle of maximum pessimism is a term I thought I had coined but I googled it just to be sure and found Sir John Templeton beat me to the punch.

"Sir John, 92 and retired from money management, calls it the "principle of maximum pessimism." In a nutshell: Don't ask which markets or sectors look attractive; ask which ones look awful and invest your money there. Since most investors don't have the guts to make those tough calls, most haven't enjoyed the success Templeton's firm has over its 50-year history."
As I mentioned in my comments that you used in one of your missives, we are not the the maximum point of pessimism in anything. People are feeling squeezed but are still in a hopeful state. This "hope" is distracting many from responding appropriately in the present moment to reality.

Hope refers to a non-existent future and despair a non-existent past. One cannot not act now in either the past or future but this is where the majority focus their minds.

It is when hope fades and is replaced by despair and loathing, or when the majority of people are fearful about the future because of the past that a bottom will be in.

As a technical trader I can appreciate and use mathematical formulae, however, I still remember Einstein's wisdom:

"As far as the laws of mathematics refer to reality, they are not certain, as far as they are certain, they do not refer to reality."

Few had the courage to buy in 1979 when the true valuation bottom occurred in stocks. In 1998 no one believed a commodity bull market was getting underway. In 2000 very few had the wisdom to sell their equities.

All of these elegant mathematical formulae existed then as they do now, how many will have the discipline to execute rationally when the time comes?"

Let's look at homebuilder KB Home as a proxy of the housing market for signs of maximum pessimism.



What is this chart telling us?

1. There are two cycles at work in housing: a macro-economic recession/expansion cycle, and a real-estate appreciation-depreciation cycle. They are not necessarily aligned, as the "doldrums" of the last housing cycle occurred during the white-hot tech boom of 1995-mid-1998.

2. At the last recession low, KBH traded for under $3 a share. It's current price of nearly $25/share is a long way from either the 1991 recession low or its last real-estate cyclical low of under $10.

3. Real estate cycles are long. KBH touched $10/share back in 1987 but did not break decisively above that resistance/support for 13 long years.

4. Housing "bottoms" are "saucer-shaped" and marked by years of doldrums. Lows in the stock market are often marked by sharp spikes of selling called capitulation, which quickly recover as traders and investors realize the world is not coming to an end.

This simply isn't the case with real estate and housing, which are far more widely distributed across the economy and far more illiquid than stocks.

The recent volatility in KBH and other housing stocks are not at all like the flat-lined doldrums that marked previous bottoms; the volatility alone suggests hope is still very much alive. Traders/investors are buying now in the hope that the "bottom" is in--but history and the principle of "maximum pessimism" does not support their optimism.


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