Home Builder 'Babies' / San Diego / Yuan

Richard Russell
Dow Theory Letters
Jul 26, 2005

Extracted from the July 25, 2005 edition of Richard's Remarks

I've been saying, and I'll repeat it -- the US economy is levitating on the back of the housing boom, a boom which some grouches refer to as "the housing bubble." I follow eight of the major home-building companies on a daily (actually hourly) basis, and I want to show you charts of two of these housing biggies below. I don't know whether the home-building stocks will provide us with the first hints of a "pin-prick" into the housing bubble, but as long as the home-building stocks work higher, there's a good chance that the housing picture will remain as the mainstay of the US economy.

Below you see a daily chart of KB home, one of the largest home-builders in the nation. The rising blue trendline tells us that KBH has been heading skyward since May. RSI shows that the stock is overbought, and the histograms are staying in the blue -- but barely. The 34-day rate-of-change at the bottom of the chart has been moving sideways, which is actually OK. The rate of change at 23.8, however, is very high and probably cannot be sustained.



Let's look at a second major home-builder, Lennar Corp. Here we see the stock holding just above its rising trendline. RSI is turning down from an overbought 70 level, and the histograms have just turned down and are just slightly below zero. The 34-day rate-of-change has definitely turned down, and this means that LEN's peak of (rising) momentum has passed. The expectation is that LEN will break below its blue rising trendline. Thus, we see the first hints of a turn in this typical large home-building stock. We'll keep our eyes on these babies -- their action is of utmost importance to the US economy.

Russell Comments -- My father was a construction (civil) engineer prior to the Great Depression -- he turned to management during the depression, because after 1929 construction came to a total, dead standstill.

My father once told me, "Dick, I never knew a builder who didn't end up broke. They always get most enthusiastic at the top. When the Depression came, all the builders went broke, but the buildings they put up stayed up. Later, those buildings were taken over and refinanced, and many of the "refinancers" made the real money.

I'm reminded of San Diego today. This beautiful city is technically broke. Its political structure has fallen apart. It's mayor has quit. It's new temporary mayor is now heading for jail. The city owes its pension fund for city workers over $1.4 billion, and the city's credit rating has collapsed. San Diego may have to declare bankruptcy. But even if SD does go bankrupt, physically, the city will remain the same. All the new buildings (and there are thousands of them) will remain standing, the weather will be the same great weather, the lovely beaches will still be here.

San Diegans don't seem at all worried about the city's possible bankruptcy. "It's the lousy politicians," they say, "They got us into this. Let them figure it out." And all those new building stand shimmering in the glorious sunlight of San Diego. You see, that's the beauty of a building boom. The builders and the buyers may end up in bankruptcy -- but the buildings get built. And they stay built no matter what the incompetent politicians or the debt-laden economy does.

The revaluation. Ah, finally, the yuan will be pegged to a basket of currencies. Nobody knows what that basket will consist of, and the basket may even be largely dollars. The basket of currencies could move up or down, so, ironically, we don't know whether this new peg will actually render the yuan higher or lower against the dollar (Gad, suppose the yuan ends up even lower compared with the dollar?). It's not clear whether the Chinese will reveal the make-up of the new basket of currencies, but clever FOREX traders will figure it out via regression analysis.

Here's my own opinion regarding what the Chinese are doing. At this early stage of the game, the Chinese are being careful to avoid a fight with the US. First of all, the Chinese are still trying to buy the Unocal oil company. And secondly, there are probably a lot of other US properties that the Chinese would like to buy. Therefore, it would hardly serve their purpose to play hard-ball with the US at this time. Note that the Chinese are emphasizing that all their transactions are economic, and business-oriented -- NOT political.

One way of raising US tempers (and fears) would be to immediately start cutting back on purchases of US bills and bonds, thereby igniting the US's worst fear, which is sharply rising US interest rates. So I believe the Chinese will hold off a while on doing anything that will arouse US fears and anger.

I believe that the Bush administration is now in the process of trying to decide whether it should view China as a friendly competitor or as a rising threat. I don't think they have decided yet. It's going to take time.

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Richard Russell
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