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Double-Dip or Not, Housing Won't Take Down Stocks

If the stock market is to continue rallying, it likely will have to do so without the housing market—still considered a lynchpin to the economic recovery.

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Hopes that housing would show an aggressive rebound this year have been dampened by prices either in a full double-dip or at least a long-term flat trend as excess inventory weighs on the market.

The latest bad news came Monday when real estate data firm Zillow said home prices fell 3 percent in the first quarter—the worst drop since the doom days of late 2008. Yet the stock market had a decent dayas the dollar steadied and equities followed commodities higher.

Rather than worry about real estate, investors seem to be propelling the market higher so long as the Federal Reserve keeps pumping money into the economy and European sovereign debt problems remain contained, if only for the moment.

"The market has rallied 100 percent without housing doing anything," says Michael Cohn, chief market strategist at Global Arena Investment Management in New York. "I really don't think the housing market per see affects anyone but those in the worst areas and the banks."

Indeed, the problems in real estate, among other things, have kept the financial sector as the worst performing group in the Standard & Poor's 500in 2011, with a price gain of less than 1 percent.

Interestingly, home builder stocks actually have been positive for the year, gaining 7 percent as measured by the SPDR S&P Homebuilders exchange-traded fund that tracks stocks in the industry. That puts it slightly ahead of the 6.5 percent gain this year for the broader S&P 500.

The market has showed strong resiliency despite the housing situation, an indication that it can weather changing dynamics at least in the short term.

"We haven't needed (housing) for two years," says Jim Paulsen, chief market strategist at Wells Capital Management in Minneapolis. "The housing market is probably going to be weak for a while. But if you look at history, oil and farming led the '70s and they were absent in the '80s. Tech led the '90s and it was absent in the 2000s. We replaced tech with construction and financial securitization. The beauty of capitalism is that it always comes up with new stuff."

Moreover, Paulsen sees a positive sign in housing—last week's jobs report that showed the private sector added 244,000 positions in April.

Jobs and housing tend to have a symbiotic relationship, so if the employment picture improves it's likely to help the housing market. The caveat to that is that some analysts are warning that job growth is unlikely to be robust and could even retreat over the summer.

Paulsen is not among the doubters, though, and believes employment will continue to gain and give at least an incremental boost to housing.

"What housing can't do is go into another huge contraction. That would definitely be a problem," he says. "I don't think housing is double-dipping. It's just flat like it's been for the last two years. The economy can grow to the 3.5 percent area with housing being flat."

What has some investors worried is whether that type of growth will be enough and whether the economy, in fact, can survive with a miserable housing market.

"Housing is still such a big part of the economy," says Beth Larsen, principal at Evermay Wealth Management in Washington, D.C. "We're in a market that's maybe fully priced-in now anyway and then you add something negative to it. That's probably not particularly good in the short run for equity prices here."

For investors, then, keeping an optimistic outlook will require acceptance that real estate is not, in market jargon, the best house in a bad neighborhood, and won't be for a while.

"You're not going to have all the stars aligned at once," says Nadav Baum, executive vice president at BPU Investment Management in Pittsburgh, Pa. "This is another supply-demand issue. You've got to clear out the supply in housing, so you're probably three to five years away. But when you look at everything else, you're getting job creation, you're getting banks loaning money, you still have zero interest rates, M&A, dividend increases, buybacks. The market's underlying pieces are really strong."