Do You Have the Guts for This Trade?
By Dr. Steve Sjuggerud
October 12, 2007
At 2:15 p.m. on Tuesday, September 18, 2007, Ben Bernanke surprised the stock market... He cut interest rates by half a percent.
While we can't know for sure, it appears that shares of homebuilders hit a bottom, on September 28. With history as our guide, the cut in interest rates by the Federal Reserve should seal the deal...
At the end of October 1990, the Fed cut interest rates to stave off recession. That cut was the beginning of a spree of interest-rate cuts... the Fed lowered rates 13 times between October 1990 and the end of 1991.
That first rate cut in October occurred within one day of the bottom of a bear market in homebuilding stocks. That bear market had been terrible... It lasted nearly a year and a half. Sentiment among homebuilders eventually dropped to the lowest levels in recorded history. And homebuilding stocks fell by 60%.
The subsequent bull market – kicked off by the October 1990 rate cut – was fantastic... Shares of homebuilders rose 554% in a little more than three years.
If you had the guts to buy homebuilders when sentiment was at record lows, and when the Fed kicked off its rate-cutting campaign, you'd have made an absolute fortune.
My friend, you have the opportunity to do exactly that, right now...
Three weeks ago, the National Association of Homebuilders announced that builder sentiment just tied its record low from the 1990-1991 recession. And the Fed just cut rates. The same two things that kicked off the last extraordinary move in housing stocks just happened again... except the move this time around could be even bigger than last time...
There's an easy way to size up value with homebuilders. This business isn't rocket science. They build homes. So all you need to do to value a homebuilder is take the assets and subtract the debts. Most of the time, that should leave you with something close to a liquidation value for the company (it's called the book value).
Historically, at real estate market peaks, investors have foolishly paid 100% premiums to book value to buy shares of homebuilders. And when real estate is suffering, investors won't even pay book value for homebuilders. So homebuilding companies sell at a discount.
On average, since 1980 (as far back as I have data), homebuilding companies have traded at a 50% premium over their book value. That's because investors expect that the homebuilders can make good money off of their assets.
But as of September 12, homebuilders were trading at a massive 26% discount to their book values. This tells us investors are scared.
And when you compare this to the overall stock market, you see how cheap it is... As a whole, U.S. stocks trade at a whopping 200% premium to their book values. To say it another way, stocks in general are four times more expensive than homebuilders. (Homebuilders are selling at 0.74 times book value, versus the overall market, which is selling for 2.97 times book.)
When I look back at the end of October 1990, stocks in general were "only" three times more expensive than homebuilders.
In short, right now, homebuilders are cheaper relative to the overall stock market than they've ever been, including late 1990, the worst time in the last generation.
I'm excited about this trade for many reasons. The biggest reason is simple... It meets my ideal criteria for investment: We now have all three things we're looking for when we buy. The three things don't come together often. When we get all three together in one trade, I call it the Holy Grail of the investment world. It's happening right now in homebuilders.
Longtime readers know these three things... In short, we try to buy 1) cheap, 2) hated investments, when 3) an uptrend is just beginning.
Right now, it appears we have that in homebuilders. And the upside potential is embarrassingly high…
Good investing,
Steve
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