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Monday, August 28, 2006

HOUSING STOCKS

I have been asked quite a bit recently about shorting housing stocks and lenders. Many people know of my forecast about a year ago for a drop in the housing market. If I am so bearish on housing, am I short the housing stocks?

The answer is no, and the chart to the left of TOLL Brothers shows why. I have learned over the years that there is an upward bias in general to the stock market, so taking short positions really requires a "loaded deck." Loading the deck in stocks for me requires, trading in sync with the trend, and having valuations that match that trend.

In uptrends I want low debt and low valuations and good earnings, and in downtrends I want high debt, high valuations, and declining earnings. As you can see from the chart to the left we do have a downtrend in price. However, as we review the other 3 categories we see that we have rising earnings, low debt, and low valuations. These are the opposite of what I am looking for to short stocks in a downtrend.

As a result of this there are no short trades. It is really as simple as that. I do not inject my opinion into my model because opinions can be so arbitrary and hence unreliable. I do believe housing is in for some trouble here, but I do not ignore my model EVER! I may miss some opportunities, but I focus on the ones I do pursue, not the ones that got away. There is always another trade, but there is not always more money for the next trade if you have chased too many marginal opportunities.

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