Are Homebuilder Stocks Early Warning Indicators for Equities in General?

Does the  behavior of the stocks of homebuilders anticipate the overall  equity market? To check, we first assemble a simple index of the performance of homebuilder stocks as the equally-weighted  average monthly return for the stocks of DR  Horton, Hovnanian,  KB  Homes, Lennar,  Ryland and Pulte,  starting with Pulte in August 1985 and adding the  others as they are listed. Comparing these returns with monthly  returns for the S&P  500 Index data for August 1985 through January 2011 (306 monthly returns), we find that:

The following scatter plot relates monthly returns for the S&P 500 Index to monthly returns for the simple homebuilders index over the entire sample period. The two indexes tend to move up and down together. The Pearson correlation is 0.56 and the R-squared statistic is 0.32, indicating that variation of the simple homebuilders index explains 32% of the behavior of the overall stock market.

Does either index reliably lead the other?

The next chart plots correlations between monthly S&P 500 Index returns and simple homebuilders index monthly returns for various lead-lag scenarios, ranging from the S&P 500 Index leads homebuilders by 12 months (-12) to homebuilders lead the S&P 500 Index by 12 months (12), for both the overall sample and the second half of the sample beginning in April 1998. The peak at “0″ is the coincident relationship depicted above.

It appears that all correlations except that for the coincident relationship are noise. In other words, neither index leads the other for the overall sample or the recent subsample.

In summary, evidence from a simple analysis of historical monthly returns does not support a belief that homebuilder stocks reliably lead or lag the overall stock market.

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