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Look to Lumber for Housing's Potential


Yesterday they rose and fell together, but are still in the black.

Yesterday's Notable Technical Developments

Stocks rallied to new intraday highs on the Dow, but then sold off in the afternoon as multiple negative divergences (weak financials, weak market internals, etc.) pulled the indices back down to just below resistance.

Bonds were hit hard by a troika of influences yesterday: rotation from safe to risk assets again (temporarily); better housing and construction data; and comments from Federal Reserve Bank of Philadelphia President Charles Plosser indicating he would prefer the central bank move more quickly to combat inflation.

Commodities traded higher on dollar weakness, but the commodities ETF (DBC) failed to close above resistance at $25.

The U.S. Dollar Index finished lower again Tuesday -- but still above support at 74.20.

Critical Market Components:

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Market Internals:

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Chart of the Day -- Lumber Futures and the Philadelphia Housing Index

  • Lumber prices are a good gauge of the health of the housing industry. Given the significance of the housing market to our economy, at ThirdWave we like to periodically check the status of both lumber (via the futures markets) and housing via the PHLX Housing Index.

  • Lumber, after being just awful from June to early October, has been on a tear to the upside recently.

  • The lumber futures have rallied all the way up to very important resistance right at $250; they actually traded above there yesterday, but then faltered and put in a "bearish engulfing candle" -- this usually signals an important reversal in direction to follow.

  • Our wave count on lumber indicates that the apparent top put in yesterday may have been the end of wave C of an ABC correction that started in March. If that is the case, then this overbought condition in lumber may quickly turn into an oversold condition as a new primary down wave may be next for the commodity.

  • Housing stocks seem to have peaked out in September and haven't participated in the broader market rally since.

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  • Yesterday, both lumber futures and housing stocks caught some significant buying interest in the morning on news that housing and construction may be improving. However, when the Federal Reserve's Charles Plosser came out with comments indicating that he favored the FOMC moving to combat inflationary pressures sooner rather than later, lumber tumbled sharply first, then housing stocks followed them lower into the close.

  • Still, though, the housing group finished the day well in the black -- so we'll watch closely going forward to see if the strength continues following the positive data points.

  • If lumber really does reverse from the blow-off high set yesterday, however, here at ThirdWave we don't think the housing stocks will stand a chance in the intermediate-term.

Strategy: Monitor lumber prices for guidance as to whether the fundamental improvements in housing are for real and as to whether the housing sector is a potential buying opportunity.

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No positions in stocks mentioned.

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