Don’t be stumped by timber prices
It’s a good choice for patient investors
I. Lumber prices are a good predictor of stock market volatility.
This may sound farfetched, but it’s the subject of an award-winning paper titled “Lumber: Worth Its Weight in Gold — Offense and Defense in Active Portfolio Management” by Michael Gayed and Charlie Bilello of Pension Partners. In a nutshell: When lumber outperforms gold over the previous 13 weeks, you should be more aggressive in the stock market, and when gold outperforms, you should be more defensive.
Why lumber? Lumber prices are a good indicator of the housing market — which, in turn, is a good indicator of the economy as a whole. Unlike most housing indicators, lumber isn’t lagged by weeks or months, as are things such as housing starts and home prices. Nearby lumber futures prices are available throughout the trading day.
Though home construction is a relatively small part of overall economic growth, it has an enor- mous ripple effect. When you buy a new home, you not only employ dozens of workers and purchase lots of raw materials, you also make work for the folks at Home Depot and Nuts 2 U Nursery.
Gold, on the other hand, is a good measure of fear. People buy gold when they think bad things will happen. “In multiple cycles, when lumber outperforms gold, the stock market tends to be less volatile,” Bilello says. “The economy is improving and in an expansionary phase. And it’s the opposite when lumber is underperforming.”
What is timber telling us now? “From the end of last year, lumber has been underperforming gold,” Bilello says. “It doesn’t mean that stocks have to go down — it simply means that there is a higher probability of volatility rising.”
How defensive you want to play the lumber indicator is up to you. You could move to intermediate-term bonds if you’re really leery of the market. Or you could move to more defensive sectors, such as health care or utilities. Or you could invest in low-volatility stocks, such as those in the S&P 500 Low Volatility Portfolio (ticker: SPLV).
Conversely, when lumber clubs gold, consider being more aggressive, either by increasing your stock holdings or increasing your holding of more volatile smallcompany stocks.
One word of warning: Wall Street currently looks at bad economic news as good, because that means the Federal Reserve will keep rates low longer. “It’s one of the few periods in history where weak economic news is being well received on Wall Street,” Bilello says. That might warp the lumber indicator a bit.
GMO, a respected Boston money manager, periodically issues a