Step 2: Use the stock market as an indicator
In the U.S., the S&P500 index is the main barometer of the economic health, composed of the top 500 U.S. blue-chip companies — some housing related. Investors use global stock markets to express their view on the real estate and housing sectors. For example, if investors think the U.S.’s housing bubble is about to burst they will start to sell or short stocks related to the American real estate and housing market.
As the chart above demonstrates the S&P500 trended downwards during the Tech Boom and Oil Crash of 2015 while building permits continued to trend higher. Therefore, it’s a powerful indication of a potential housing bust or boom when the S&P500 starts trending along with the building permits indicator — look closely at August 2007.
If the housing market performs poorly, that doesn’t mean the S&P500 moves in tandem with our indicators, in fact, housing stocks also tend not to follow the index either. This is because housing stocks follow our leading indicators instead!
Diving deeper into the market we can find stocks that follow and lag our leading indicators.
Homebuilders started to struggle and contract in 2007, long before the S&P500 tumbled. The doom and gloomers — who turned out to be right — began taking positions in credit default swaps on mortgage bonds just before the subprime crisis occurred, using stocks as an indication of decreasing sentiment within real estate and housing sectors.
What we’ve learned is the stock market can predict a housing crisis long before the crash occurs! It’s also important to remember that real estate and housing stocks follow the leading indicators we’ve utilized and not the stock market as a whole because the former is the most accurate barometer of housing sector health!