The similarity between what Greenspan said last week — and In 1999
If the first rule of investing is "Don’t fight the
Fed" then investors and traders should steer clear of homebuilder and
REIT stocks. Make no mistake, as his remarks from last week indicated, Chairman
Alan Greenspan has a bead on rising housing prices.
There’s an eerie similarity between Greenspan’s remarks in 1999, as the
Federal Reserve began increasing interest rates to stem the Internet stock
bubble, and those he made last week at the annual Federal Reserve Bank of Kansas
City symposium. The only difference is, last week, Greenspan targeted rising
home prices instead of rising equity prices.
I have included key excerpts from speeches in the two interest tightening
cycles. The first quote comes from mid 1999, after the Federal Reserve first
raised interest rates. The second quote comes from last week. And in case your
"Fed-speak" is rusty, I’ll summarize. Greenspan essentially believes that
excessive increases in prices (stocks, bonds or homes) are bad because, when
they reverse, they negatively affect all other parts of the economy. Therefore,
he believes it is better to pop the bubble through tighter monetary policy, than
let the market run its course.
"Equity prices figure importantly in that forecasting process because they
influence aggregate demand….Should an asset bubble arise, or even if one is
already in train, monetary policy properly calibrated can doubtless mitigate
at least part of the impact on the economy. And, obviously, if we could find a
way to prevent or deflate emerging bubbles, we would be better off….The
danger is that in these circumstances, an unwarranted, perhaps euphoric,
extension of recent developments can drive equity prices to levels that are
unsupportable even if risks in the future become relatively small. Such
straying above fundamentals could create problems for our economy when the
inevitable adjustment occurs. It is the job of economic policy makers to
mitigate the fallout when it occurs and, hopefully, ease the transition to the
next expansion."
— CHAIRMAN ALAN GREENSPAN, Committee on Banking and Financial Services,
U.S. House of Representatives, July 22, 1999
"The rising prices of stocks, bonds and, more recently, of homes, have
engendered a large increase in the market value of claims which, when
converted to cash, are a source of purchasing power….Such an increase in
market value is too often viewed by market participants as structural and
permanent….Any onset of increased investor caution elevates risk premiums
and, as a consequence, lowers asset values and promotes the liquidation of the
debt that supported higher asset prices. This is the reason that history has
not dealt kindly with the aftermath of protracted periods of low risk
premiums.If we can maintain an adequate degree of flexibility, some of America’s
economic imbalances, most notably the large current-account deficit and the
housing boom, can be rectified by adjustments in prices, interest rates, and
exchange rates rather than through more-wrenching changes in output, incomes,
and employment."
— CHAIRMAN ALAN GREENSPAN, Kansas City Federal Reserve Bank Symposium,
August 26, 2005
Since short term interest rates are the Federal Reserve’s only weapon to
fight bubbles, the Chairman’s desire to defeat the "housing boom" will have
consequences for the entire economy. However, it will have the most consequence
for the home building and REIT sectors.
Homebuilder stocks, as measured by the Philadelphia Housing Index (HGX), are
already nearing important long-term support as shown in the weekly chart. A
break below the 515 level would indicate a move to the next level of support at
450.
Several components of the HGX index have already broken short-term uptrends
and are poised to retreat to longer term support. For example, Toll Brothers
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PowerRating) has already broken its first rising trendline at $50 and looks to be
headed for a test of the longer term trend around $35. While it is sitting on
some minor support at current levels, the risk to reward seems to be skewed to
the negative side.
REITs, which are even more closely tied to interest rates than homebuilder
stocks, could also have a tough time. The Dow Jones REIT Index
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is forming an ominous looking long term rising wedge, which typically breaks to
the downside.
Despite his penchant for rambling, Greenspan couldn’t have been clearer in
his message last week. Investors and traders should take heed of Greenspan’s
remarks because equities tied to housing demand could be in for a difficult time
until the Federal Reserve is satisfied that housing prices have begun to
decline.
Thomas Neuhaus
Thomas Neuhaus is a principle of Investment Management of Virginia, a
registered investment advisory firm for which he co-manages. Mr. Neuhaus’ career
has encompassed all aspects of the investment business from investment banking
to sell-side research to buy-side portfolio manager.