Can Wall Street withstand weak housing?

By this view, stocks aren't a good choice right now. What, then? Barry Hyman, equity market strategist for EKN Financial Services, says that the same rising rates that have squeezed housing have given investors a nice alternative: money market accounts, which are yielding better than 4 percent, and bank certificates of deposit, some of which yield 5 percent or more.

'Down But Not Out'
Super-bears on housing have different advice. John Talbott, author of the none-too-subtly titled "Sell Now! The End of the Housing Bubble," recommends avoiding not only the stock market, but banks, too, since lots of banks could be hurt by lax mortgage lending standards.

But not everyone is convinced that housing will crush stocks. Why? Some figure that the housing slump won't be severe or prolonged. Robert DiClemente of Citigroup argues that the adjustment to a slower rate of sales is well under way. He says that the issuance of building permits is actually 10 percent below the rate of new-home sales. This process "will clear the overhang of houses within the next six to nine months," DiClemente predicts in a recent research note. The headline on his report: "Down But Not Out."

Others say it's too soon to declare the stock market dead because of housing. "Summing it up, I'm in the camp that says I don't know and the jury is still out," says Jeffrey Saut, equity strategist for Raymond James Financial.

Back to the future
Then there are the outright optimists. Bob Carey, chief investment officer for First Trust Advisors in Lisle, Ill., says that the stock market is 20 percent to 25 percent undervalued at current levels and should reach full valuation by sometime next year, which means: Get ready for a heck of a bull market. Carey says the demand for housing is driven by incomes and jobs, and since corporate profits are extremely strong, the outlook for income and job growth is good. Says Carey: "It's hard to imagine Corporate America doing well and somehow people not doing well on the employment side."

Carey has seen Merrill Lynch's chart showing a tight correlation between homebuilding and the S&P, but he says the pattern dates back only a decade or so. Before then, there was very little correlation, and he says the economy might return to that older pattern.

It's also possible that the housing slowdown could prod the Federal Reserve into cutting interest rates, which could boost stocks. Maybe, too, speculative investors will go back to dabbling in stocks instead of real estate, the way they did before the dot-com bubble burst and the real estate boom began.

Today's market
But the most intriguing evidence that the stock market might not go down because of a housing slump is simply this: So far, it hasn't gone down. It's gone up. The stock market is famous for looking ahead, and it seems that investors collectively may have decided not to blow a gasket over housing. This past June, the S&P 500 got down to around 1,220. Now, with the news about housing getting steadily worse, it's up to 1,321, and on the verge of setting a five-year high.

Even more intriguing is that stocks of homebuilders  — a group that's been out of favor for quite a while  — show signs of bottoming out. Since their lows in early September, Pulte Homes is up 14  percent, D.R. Horton is up 16 percent, Lennar is up 8 percent, and KB Home is up 14 percent. If the stocks at the very epicenter of the housing slump can show signs of life, why is everyone so worried about the market as a whole? Good question.

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