Lo de las subprime no acabará en caos

"Millions at risk of losing homes" was the headline on the news wires on Wednesday, March 14. This happened on the day when the stock market showed a positive intraday reversal on strong trading volume. Obviously, the stock market wasn't put off by this negative piece of news.

Could the scare stories over the sub-prime lending debacle be the final wash-out phase of the U.S. housing market correction? I think it could be. It's certainly typical of past wash-outs of bear markets and as usual the mainstream press is doing a stellar job of exaggerating the negatives and trying to scare the country.

It doesn't get much more bearish than that! I take this barrage of pessimistic headlines to be a contrarian indicator that the worst has already been discounted by the markets and it shouldn't have that great of an impact on the national economy. This isn't to say that the sub-prime mortgage problem is just going to vanish overnight without any pain or negative consequences, for there almost certainly will be more. But as far as major national economic pain...doubtful. Sub-prime borrowers are more often than not equity rich and yet don't always pay their bills on time. It's not as if they're dirt poor and one paycheck away from the curb as the media would have us believe.

Major long-term tops aren't characterized by problems coming to the surface: this is one of the attributes of a bottoming or digestion (consolidation) process. At the top of a major bull market the news is nearly always upbeat, especially on the economic front, and bad news is nowhere to be found on the front pages of newspapers.

The Dow Jones REIT Index (DJR) has been showing some relative strength recently compared to the S&P 500 Index (SPX). Even the Housing Sector Index (HGX) is still well off its lows of last July and has only retraced about 50% of its July-February recovery rally. If the national real estate market were in nearly as bad of shape as the media would have us believe, then HGX and DJR would be in much worse condition.

The tape action of Wednesday's (Mar. 14) intraday turnaround was promising. Volumes were good and investor sentiment couldn't be more bearish right now (which is positive from a contrarian standpoint). The AAII investor sentiment poll came out showing only 33% bulls (one of the lowest readings of the past year) while the percentage of bearish investors was a fairly high 45%. This is the third consecutive net bearish reading of the weekly AAII poll and the bear-to-bull ratio this week was second only to the major interim low of last July.

Another area that isn't as bad as it's being made out is the emerging markets. Veteran market forecaster Steve Todd brought something to my attention recently that's worth repeating. He pointed out that the Emerging Market ETF (EEM) tends to lead the S&P at turning points and as such can be used as a leading indicator for the SPX. At the most recent low the EEM made a distinctively higher low compared to the SPX. This shows relative strength and suggests the SPX should find its legs and regain its strength.