The 18 Year Real Estate Cycle

Sometime around 2004, I remember telling a patient that real estate was forming a bubble and that it was soon to peak and then pop & deflate.  This generally very nice person then sharply stated: “You’re wrong, real estate never goes down!”  Later, in 2008, the market taught us otherwise when real estate collapsed.

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The world around us appears to run on what can be viewed as “somewhat regular cycles.”  There is a New Moon every 27.3 days.  Birds fly south at the same time each year in response to repeating weather cycles.  Economic cycles run through a repeating pattern of boom and bust that normally lasts around 5 years.  And there also appears to be an 18 year real estate cycle that does not jive with the business cycle or the bond cycle or the stock market cycle; it dances alone.  This particular 18 year cycle has been reliably traced back to the 1800’s.

The 18 year cycle was first introduced by economist Homer Hoyt in 1930 and then by Clarence Long in 1940.  It was later studied by Akhil Patel who wrote an article in 2014 for The Society of Technical Analysts Journal.  It was titled:  Why Traders Need to Understand the 18 Year Real Estate Cycle.

75 years ago, Hoyt and Long had first predicted future real estate cycles, getting the 2006/2007 top correct and its subsequent bottom in 2011 equally correct (in 1930, Hoyt accurately predicted the big housing/financial crash that would eventually start in 2007!!).  Their predictions continued for a moderate 2 year mid-cycle downturn to show up in 2018-2019 and then a renewed run until a major top forms sometime around 2026, followed by a new 4 year crash.  I can currently see the very early beginnings of a temporary peak forming in real estate.

MarketCycle’s particular expertise is in market cycles (obviously).  Another way to look at this is that the economy (and businesses) definitely go through a repeating, multi-year boom-bust sequence and MarketCycle looks at how financial assets react during these slowly rolling economic periods.  We seek to exploit the resultant cyclic conditions with the goal of increasing gains while reducing portfolio risk.  So, if I were to combine the 18 year real estate cycle with what I already (loosely) feel might occur in the secular market cycle, then my guess would be almost identical:  Real estate may temporarily peak in 2018-2019 (same as Hoyt & Long), and then fall, and then bottom around 2020 (same), and then home prices start to move back up sometime around 2021 (same)… and then forming a final bubble top sometime around 2027 (same).  IMO, these are actually guesstimates since the 18 year real estate cycle is an imperfect science and a bit too esoteric for my tastes.

The normal (multi-year) repeating MARKET CYCLE process (regardless of the 18 year real estate cycle) is as follows:

1. In my opinion, we are in the second half of the late-stage of the market cycle and, if I squint, I can see an economic recession on the far distant horizon.  The U.K. and the European Union (except for the far northern countries) are already rapidly weakening while the United States is still being propped up with tax-cut support.  Emerging Markets, commodity producers like Brazil, are being helped via growing inflation and its upward effect on commodity prices.
2. The Federal Reserve has already begun to raise interest rates in response to rising inflation and rising commodity prices and an overheating economy.
3. Home construction and home prices peak first and then start to drop in response to steadily rising costs.
4. Then, sometime later, stocks start to roll over and drop.
5. Then commodities peak and fall rapidly.
6. Economic recession starts and conditions rapidly worsen and there is nothing but bad news.
7. The majority of investors (buy & holders) ride the stock market down and take big portfolio losses; they then sell at the bottom, in a panic and at the same time that institutional investors are forced to sell because of ‘margin calls’ (their ‘leverage’ loans are called in).
8. The Federal Reserve lowers interest rates in response to difficult economic conditions; it wants to stimulate lending and home buying.
9. Home construction starts to pick up again and home prices begin to rise in response to the now lower interest rates.
10. Although the news and economy are still bad, the early-stage of the market cycle arrives and stocks begin to bottom and then move back up, starting with very particular assets and sectors.
11. The economic recession officially ends after the stock market has already had a dramatic and very profitable rise; despite what they now believe, the majority of investors will miss out on the opportunity because they will remain so filled with fear.
12. The Federal Reserve eventually begins to raise interest rates in response to rising inflation and rising commodity prices and an overheating economy.
13. The average retail investor is now ready to buy stocks.
14. Home construction and home prices peak and then start a (mild) drop in response to the Federal reserve raising interest rates which makes ‘costs’ steadily rise.
15. Repeat.

The only difference in the above repeating market cycle pattern is that the 18 year real estate cycle adds this prediction:  The U.S. home construction and home price downturn in 2018-2019 might be worse than usual, but not as bad as in either 2008 or in the one predicted for a decade from now.  And global real estate patterns are closely linked to the United States real estate pattern.  As I keep repeating, because of the huge size of the U.S. economy, “When the United States sneezes, the rest of the world catches a cold.”

What does MarketCycle feel is the most surprising thing about the 4 stages of the market cycle?  It is that, despite the cycle repeating over and over and over and over again, for centuries and at roughly 5 year intervals, almost nobody understands what it is.  Nobody gets it.  Every time we enter the ‘early-stage,’ investors sit around with a confused expression on their faces; every time we move into the ‘late-stage,’ investors finally give up their bearish views and start to buy stocks with abandon; every time we slip into the ‘recession-stage,’ investors seem paralyzed with confusion, knowing that something is happening but they are not sure what… or what to do about it.  I remember Richard Dennis, one of the greatest investors of all time, saying that he could publish his investing rules in the newspaper and still “no one would get it.”

What’s happening right now?  The Federal Reserve has already been raising interest rates (borrowing costs) in response to rising inflation and rising commodity prices.  The result is that HOME CONSTRUCTION looks like it is beginning to weaken:

And the commodity costs of home building (such as LUMBER) are absolutely sky high, making building costs equally sky high.  This shows that inflation is rapidly rising, which is a late-stage phenomenon in the all-important market cycle:

That’s it; thanks for reading!

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Article by Stephen Aust, MarketCycle Wealth Management