Market bottom or bear rally?

I have been noticing a great deal of bullishness during this spring rally, and I was planning a post to put things in perspective, but Rich beat me to it. His analysis was so well done, that I want to acknowledge it here and add my own comments.

Perspective on the Home Price Rally

I noted earlier in the week (and incessantly before that) that home prices have a seasonal tendency to rise in the spring and summer even during the midst of a multi-year price decline.

That sounds like a good enough excuse to make a chart.

Below you will find a look at San Diego home prices, as measured by the Case-Shiller index, from 1990 through 1996. These years encompassed the entirety of the five-or-so year home price decline visited upon San Diego after the late-1980s housing bubble.



As you can see, the Case-Shiller index measured a rise in aggregate San Diego home prices for every single year of the long price decline. (Although 1993 just squeaked in there with a one-month, .1 percent increase).

I’ll bet that during each of those spring rallies, a lot of people became filled with hope the housing bust was finally over. But through five of these head-fakes, it wasn’t.

Here for comparison is a look at the current housing downturn:



After an anemic spring bounce in 2006, the Case-Shiller index fell unceasingly through 2007 and 2008, only to finally register an uptick again earlier this year. The lack of spring-summer rallies is a testament to the brutality of this housing crash.

The next graph overlays the two housing crashes in order to compared duration and magnitude:



The price decline this time around has been substantially larger — an outcome that was unsurprising based on the comparatively vast overvaluation of homes coming into the 2005 bubble peak. But while it may feel to some like this price decline has gone on forever, it has not yet endured nearly as long as the 1990s version.

Whether it eventually does so remains to be seen. Either way, the first graph should make it clear that a spring-summer home price rally should not be taken as evidence that the housing bust has come to an end.


If there is one thing you need to take away from the analysis, it is this: housing prices often move against the prevailing downtrend for spring rallies. It doesn’t mean the trend has reversed direction.

You can make the argument that the early 90s was different or that San Diego is not Irvine, but there are more similarities than there are differences. It is very unlikely that we are at a bottom. It is more likely that we will continue to see declines for another two or three years followed by tepid appreciation. For a durable bottom, we need rising employment, an expanding economy, stability at the low end of the market, stable financing, and a host of other conditions we do not currently enjoy. This isn’t over yet.

While we are talking about Rich Toscano, I want to call attention to an old article of his that addresses our other buying phenomenon here in Irvine: foreign cash buyers. Rich wrote a piece called Dumb Money, to describe how foreign buyers end up being the knife catchers.

One argument I hear a lot is that foreign demand for local real estate has grown substantially in recent years, and that such foreign demand will be supportive of prices in the future.

Unfortunately, this argument puts the cart squarely in front of the horse. Investors from other countries are well known to be the very last participants to arrive at the scene of a financial bubble. They are the last to hear about all the riches to be made, the last to buy in, and the last to realize that the party is over.

The chart to the right provides an example from the history of bubbles past. The blue line represents the price of the Nasdaq Composite Index during its late-1990s flight to the heavens, along with the very beginning of its eventual journey back to earth. The red line denotes the dollar amount of U.S. stock purchases made by foreign investors.

It can easily be seen that foreign buyers chased the U.S. tech stock bubble all the way to the tippy top, and that they lagged prices the entire way. The final onslaught of foreign cash did not even hit our shores until after the Nasdaq had begun to decline from its final peak.

Far from being a positive fundamental, a sudden excess of foreign participation in an asset market is indicative of ill-informed speculative money at work. When the foreigners really start piling on, it’s always a good sign that the end of the bubble is nigh.


The activity of foreign buyers with cash is not new or surprising. Rich wrote about what we are seeing today back in December of 2006. This activity will go on until the cash is spent, then prices will resume their decline.