King Canute famously (and unsuccessfully) commanded the tide not to come in to demonstrate to his sycophantic followers that he really didn’t have the power to alter the course of nature. It would be worthwhile for the U.S. government to learn that lesson.
The Economist had a short blog piece on July new home sales. In this case, a picture is worth a thousand words.
(click to enlarge) Source: The Economist, Calculated Risk
This is a long-term view of new home sales going back into the early 1960s. You can see that there was cyclical variation between about 400,000 and 800,000 units for many years during the baby boom. In the late 1990s, for whatever reason, home sales took off. Maybe demand for homes was actually higher between the aging baby boomers and new echo boomers just going into the housing market, or maybe it was just real estate speculation-it doesn’t really matter. Demand was huge and housing boomed.
After demand was satiated, the market peaked around 2006 and has since been in a steady decline. Although the boom was encouraged, the decline on the flip side has been considered a bad thing by the government. In 2009, the U.S. government approved a large national stimulus package to revive the overall economy and a significant new housing tax credit to specifically encourage home purchases.
On the chart, the intervention effect of the largest global economic superpower in history can be seen as the small recent blip around the 400,000 unit area. As soon as the artificial stimulus was ended, new home sales resumed their decline. Some economists look at this as evidence that we need more stimulus. I look at it as evidence that the market is going to find the equilibrium point between supply and demand sooner or later, whether the government interferes or not. If prices continue to fall and housing becomes a bargain versus renting, unit sales will probably rebound more quickly than if demand is temporarily manipulated by intervention.
That’s how free markets, including the stock market, are supposed to work. Markets are price discovery mechanisms for finding the equilibrium point for supply and demand. Price discovery is a natural process of markets. Relative strength allows an investor to identify those areas where demand is in control of the situation, although one never knows exactly how long it will last. By systematically rotating toward relative strength, an investor over time may have the opportunity to earn outsized returns. King Canute knew that you needed to go with the flow and market participants would do well to heed that lesson today.
