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Real Estate Technical Breakdown and Report


In recent years, most REITs and ETFs that track real estate have coincided with the overall market. But there are ways to gain information from price movement that vary from the broad indices.


Case-Shiller Index

The Case-Shiller home price index number came out yesterday and yielded a 3.8% decline on a year-over-year basis for the month of August. As a technical analyst and market technician I tend not to pay too much attention to these figures. The reaction when the numbers are "digested" is more important, and more important still is the broader trend. While I agree that Case-Shiller and other measures of home prices are important measures of the strength or weakness of housing in the US, they are unarguably measures of the past, and thus are wholly unusable as a means to profit in the market at worst, or susceptible to flaws and lag at best.

Technical Analysis

Compare these economic numbers to technical analysis. Technical analysis is a measure of present conditions blended with the future expectations. The study is and always will be an economic method of study. I say this in the sense that supply and demand are the determinants of market price in free market capitalism. You could even say that technical analysis is simply the study of supply and demand changes. It might seem like a foreign concept to apply technical analysis to the real estate market, but as long as the criteria for technical analysis are met, any supply and demand output can be evaluated. Today we'll look at publicly traded REITs using the Dow Jones Equity REIT Total Return Index as a proxy for the state of the overall real estate market.

Real Estate and REITs

Traditionally, the housing sector is a leading indicator of the economy. That may be true on a macro and fundamental level. However in recent years, most REITs and ETFs that track real estate typically have coincided with the overall market. This does not mean that analyzing this sector will be fruitless – far from it. There are several ways to gather and interpret information from price movement such as support and resistance levels, patterns, and strength or weakness that vary from the broad indices, and therein lies the value of our analysis. In addition we will look at REIT sub-sectors in attempts to identify areas that have greater prospects for profit as well as those that may be at higher risk to the underlying economic forces.

Charted below is the Dow Jones Equity REIT Total Return Index. The first thing I'd like to point out is the comparison between this index and the S&P. This can be done by looking at the price of the S&P itself (plotted in Box 2 below) as well as directly comparing this index to the performance of the S&P as a measure of relative strength (plotted in Box 3 below). The green line across Box 2 marks resistance that has been overcome, while the red line marks stronger resistance that has yet to be overcome. Whether or not this second level of resistance is overcome is another matter.

Now take a look at the relative strength of the REIT Total Return against the S&P in Box 3. Since mid-April of this year to October it has out-performed the market with the exception of two very slight periods of underperformance. From this chart we can gather that the faster the market declines, the more REITs fall in proportion (Figure A). This notion is supported at Figure B where a less precipitous decline has resulted in a slower relative strength decline, but one that reflects the somewhat hasty decline of the market beginning in mid-September. Perhaps it is a case of re-opened investor wounds and emotional decision-making that caused such severe relative drops since we know investors are considered to be "once bitten, twice shy." Whatever the case is, we are not concerned with the "why."

If we can expect the markets to rise or remain flat, then the recent past precedent in relative strength suggests that REITs will continue to outperform the market. The blue downtrend line in Box 3 was recently broken while performance simultaneously improved against the market with a dip below and then back above the zero line at C. A combination of two breaks like this increases the strength of the signal, and the strength is increased further still when compared to historical lows in performance marked by the orange line. Keep in mind these signals are for relative strength performance, meaning that REITs are likely to continue outperforming the broader market – not an indication that their prices are likely to increase (this must be evaluated separately).

Now if I could bring you back to the chart itself. Unlike the S&P, the performance of the REITs has yet to overcome resistance in the same way. Both the green and red lines are drawn to reflect what I believe to be coincident support and resistance levels with the S&P. This means that real estate may actually be lagging the market, and given the steady erosion of strength in this sector this is not completely unexpected. If the green resistance line is overcome, price should gravitate towards the vicinity of the red resistance line. The red line is only an estimate and is predicated on the fact that REITs generally have less clear support and resistance levels than stocks. Nevertheless, this is a potentially short-term profitable long setup.

Strengthening the bullish argument for REITs and real estate is the developing W Bottom pattern seen on the Total Return Index. The pattern may also be considered an "Adam and Eve" Double Bottom. Whatever the case, the name is unimportant, and the implications are paramount. A successful W or Double Bottom pattern would indicate the likelihood of seeing higher prices in the intermediate-term. In addition to the developing pattern there is a bullish divergence on the MACD (Box 1) marked by the fuchsia lines. One last sign of strength is the rising blue trendline and penetration of the blue parallel. If price can successfully advance faster than the rise of the blue parallel, it is an indication of the strength of this sector and a buying signal. The blue parallel will at that point also function as short-term support.

A principle of technical analysis is that the significance of patterns reflects their duration and magnitude. In this case the pattern is roughly three months long and counting with a magnitude of 18%. Based on the magnitude of the pattern, a confirmed W or Double Bottom would give a minimum target of 1049.52 for this particular index. This is done simply by adding the depth of the pattern to the top of the "W." A completed pattern would lead one to expect a price rise equivalent to either the minimum price or a rise that lasts roughly the same length of the pattern. The pattern will be decisively completed when the price closes above the high point at 910.98 for three consecutive days. Until that time no implications are noted.

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