The Stock Market’s Oblivious Run

Consider these two startling studies:

— During the past ten years, the average number of new homes built and for sale in the U.S. at any give time was about 350,000 units. In 2005, that number ballooned to 450,000. Today, we are sitting with 550,000 new homes for sale in the U.S.–57% higher than the ten year average.

— According to a study by First American Real Estate Solutions, as of early this year 29% of people who bought homes in the U.S. during the first nine months of 2005 were sitting with equity of zero or less. Another 5% decline in U.S. home prices would result in close to 40% of 2005 home buyers having zero or negative equity in their homes.

So here’s what we have dear reader: Home ownership in the U.S. is at a record high. Personal debt in the U.S. is at a record high. The personal savings rate in the U.S. is at record low. And housing prices are declining. If this isn’t a recipe for disaster, I don’t know what is.

Of the 49 major economists reporting to a WSJ.com survey, a ratio of 2 to 1 said the worst for the U.S. housing market is over. Wall Street and the stock market go along the merrily way oblivious to what’s happening in the housing market.

Sure, I’ve heard all kinds of stories about why the stock is strong in the wake of a weak real estate market: We’re in for a soft landing in real estate, not a hard landing. A decline in real estate prices will result in money going back into stocks from real estate. It’s only the lower income earners in the U.S. that will be affected by the housing decline. All this reasoning… simple unsubstantiated ramblings to me.

Let’s get real. The Dow Jones Industrial Average is near its record peak because the money supply and liquidity in the system has never been so great. (But take into account inflation since 1999 and the Dow Jones is still well below its record high.)

If I were investing in stocks, I’d be wary of the big cap stocks and blue-chips that are dependent on U.S. consumer spending. I ruled out home building and retail stocks long ago… and there may be more categories of stocks that may be hurt as the U.S. economy slows. History has proven small-cap companies with niche markets, new products or new capable management has always beaten the performance of big companies. This is no time to bet against that historic trend.