Trader’s Narrative

Almost a year ago I asked rhetorically, is the REIT bull market over? My own take on it at the time was that what we were seeing was yet another correction and not a top, as it actually turned out to be - in hindsight.

So where did I go wrong?

For starters, unlike the Canadian REITs (which I was also wrong on by the way) the US REIT index had an ominous head and shoulder formation. I downplayed this because of its “obviousness”.

But the head and shoulder pattern completed and price broke through the neckline. This same level corresponded to the bull market trendline. So because of this multiple significance it was important what price did near this level.

Back when I wrote about US REITs last, the breadth in the sector was really bad with only 20% or so above their 50 day moving average. This is a short term metric however and does not provide signposts for a longer term outlook. The REIT index did snap back sharply into June 2007. But from then on it was on a continuous and relentless decline.

The next rally created a lower high and the subsequent reaction a lower low. REITs were now in a clearly new market condition. As you can see from the chart, a bull market means that price stays well above its long term moving average. It only sporadically comes back to meet or pierce the 200 day moving average. The previous time that the REIT Index was “under water” this long was prior to the final base building in 2002-2003.

Trend Change or Correction
It is extremely difficult to pinpoint a major change in trend - at least I almost always find it extremely challenging. I have enough trouble with short to medium term inflection points. So I prefer to assume that there isn’t a major trend in store unless I’m proven wrong.

I prefer this not only because of the difficulty in separating a major trend change from a normal run of the mill correction but because the former only happens once in a blue moon while the latter occurs much more frequently. So I’m more than happy to take my chances because probability is on my side.

Powerless Fed
My other mistake was in attributing too much power to the Fed. I correctly thought they would soon start to lower interest rates. But my mistake was in thinking that this would be able to halt or reverse any weakness in the housing market. The rot in this sector was beyond the imagination of even the most die hard shorts.

What Now?
The only positive “spin” I can put on the abysmal REIT performance is that unlike most investments in the stock market, REITs are specifically built to be income vehicles. So while your holdings may be underwater, as an investor you are continuing to earn monthly or quarterly income from holding them. And depending on the particular REIT in question this can be a substantial amount. But this is only consolation for the long term investors, not the nimble short term traders.

Until we see the REIT Index (DJR) or the REIT iShares (IYR) or similar proxy carve out higher highs and higher lows, I can’t say it has flipped into bull mode. The disadvantage is that while by that time we may be confident, the inflection point will be far gone and with it, a good chunk of price performance.

Although I was early, my skepticism about the growth story of Crocs (CROX) turned out to be right on the money.

The dream turned into a nightmare for the longs with an almost 40% gap down on November 1st 2007. Although it would have been very painful, the best option - in hindsight - would have been to sell right there and then.

That’s because when Wall St. turns on a one time growth darling… it can get very ugly.

Double Whammy
For one, no growth investor or swing trader wants to ride along with management when they were either blindsided by a slowdown or saw it coming and were coy and didn’t communicate it in advance.

As well, declining sales/growth reduces the valuation of a company. And it has the levered effect of also reducing the multiple used to value it: the price earnings ratio. So the company is hit with a double whammy.

Very few are able to recover from this. That’s why it is dangerous to fall in love with a stock, no matter how persuasive the arguments. A stock is a stock is a stock.

But with Crocs, I was a bit puzzled at how people could actually could like them, never mind love them (as a product or a stock). In any case, now that the whole sorry saga has played out, here’s the chart:

Other than the obvious line break (blue) that spelled the end of the run, it is interesting that each gap down was below the previous swing low. What more obvious sign that buyers were simply not showing up?

In other words, in each subsequent price realignment, it missed previously established support levels. Until finally, it is now trading below the first double bottom in 2006.

It is safe to say almost all longs are now underwater and unhappy. Which means that if a miracle delivers a rally, they will be so relieved to be able to get out with any semblance of break even, it will be a short lived rally.

Other than running away from former growth stock darlings, Crocs has other useful lessons. Study the first few months of CROX and notice how it built a base from which it launched a massive run. It almost looks like two back to back cup and handle formations. Now go and find stocks which have similar bases. IPOs are great candidates for growth but they are few and far in between these days.