Sunday, October 24, 2010

Have We Caught Up To The Can?

We are all familiar with the phrase "kicking the can down the road". The origins of the phrase are unknown to me, but certainly we've all been hiking or walking and played our own version of "kick the can" by knocking a pine cone or rock out of the way with our foot. Eventually, as time goes on, you come up to that object again and have to confront it.

This phrase has been used to describe the current financial situation in the United States with regards to the unwinding of the real estate bubble. Many of the solutions the government and Federal Reserve have tried -- tax credits, low interest rates, home buying incentives -- have merely delayed the inevitable for some homeowners. Many still remain underwater, and of those, quite a few are in very fragile financial situations due to loss of work, lack of savings or both. For this reason, they could foreclose at any time. The failure of government and the "free market" economy to create the kind of vibrant growth necessary to avoid a double dip in housing has to be on the top of the list for most investors who are bearish on the US economy.

Rather than go into all the economic reasons for a double dip in housing, I will approach it from the charts. I will only explain why we could be at a turning point in housing. I will not suggest that the turn will be for the worse, because I don't know. I just know that if there is going to be a turn, there is good reason to believe it happens now.

First, the real estate ETF (IYR) just hit the 61.8% Fibonacci retracement level going back to the 2007 peak. To believe that these REITs and real estate related stocks will retrace all of the price move up to the peak of the housing bubble seems a virtual impossibility. The situation turned very negative, and a retracement is a natural part of any long-term trend. To say we can go back to the levels at the peak of the bubble is a radical prediction, to say the least. For that reason, I feel that if housing doesn't turn lower now, it will probably turn when the IYR hits the 78.6% Fibonacci retracement level.

The second big reason why housing could double dip from a charting point of view is the amount of adjustable rate loans that will begin to reset in the near future. The Fed has attempted to lower mortgage rates aggressively, probably in anticipation of these resets, but rates are now beginning to turn higher. The question is whether or not the Fed can suppress what nature is wanting so badly to do -- to turn interest rates higher in light of the heightened risk associated with US debt. Notice how the height of sub-prime corresponded to the market collapse in 2008. The option adjustable rate mortgages peak in 2011, so it is reasonable to think we could face serious headwinds in the financial markets heading into late 2011.

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