Last week I read an interesting article that I almost mentioned here. The article, titled Can the economy survive the housing bust? was posted on CNNMoney and written by Jon Birger, senior writer at Fortune magazine. First, let’s look at how the article opens:

Tucked away in the briefcase of Liz Ann Sonders, chief investment strategist at Charles Schwab & Co., is a chart so scary she’s hesitant to show it to investors.

Holy crap! That sounds pretty scary, don’t it? I mean, surely the chief investment strategist at Charles Schwab has been around the block once or twice and knows bad things when she sees it. So what is this terrifying chart?

It plots the National Association of Home Builders’ Housing Market index - a monthly measure of builder confidence - against the Standard & Poor’s 500 stock market index, with a one-year lag.

Okay, I see. So the NAHB index is supposed to tell us something about the future direction of the S&P 500. What does it show?

It turns out that the mood of builders is a terrific stock market bellwether

Yeah, okay, I already said that. Get to the point.

The correlation between current builder confidence and future stock market returns over the past ten years is downright unnerving.

Oh? How unnerving?

Not only did the NAHB index presage the start of the post-1994 bull market in stocks, but its decline starting in 1999 foreshadowed the equity market collapse that came the following year. Builder confidence rebounded in November 2001 - a year ahead of the stock market upswing that began in October 2002.

Why is Sonders worried now? Just look at the chart.

What chart? Oh, the one below this.

Over the past year, the NAHB housing index plummeted 54 percent. Were stocks to follow suit, the S&P - 1400 in late October - would be trading below 700 this time next year.

HOLY CRAP! SELL! SELL! SELL!

I have to admit that is a pretty scary chart. To be fair, the article went on to note:

Sonders isn’t predicting anything so apocalyptic, but she doesn’t hide her concern about housing and her pessimism about stocks.

Okay, I happen to agree. While I think the economy is headed for a slow down, I think even the most pessimistic investors wouldn’t expect the S&P 500 to fall back to 700 in the next twelve months.

So that was the article. I thought it was pretty interesting, even though it was indeed perhaps a bit unnerving.

Then, today I was reading a wonderful blog called Calculated Risk and saw the aforementioned article discussed right here.

What did Calculated Risk have to say about this?

This is an example of a forced correlation. By picking a certain time period, and adjusting the scales, the correlation looks very strong.

The first thing you should note is that the CNNMoney chart begins in 1994. What the article fails to mention is that the index in question was introduced in 1985. Back to Calculated Risk:

But here is a comparison over a longer period - since 1985 when the NAHB Builder confidence index was introduced. In the long run, Builder confidence moves between about 20 and 70, whereas the S&P 500 trends higher. So the comparison breaks down over a longer period.

Okay, what does that chart (from Calculated Risk) look like:

Oops! Looks like the “correlation” does indeed fall apart in the long run. In fact, even in the last ten years, the correlation isn’t actually as strong as the CNNMoney chart suggests.So, what to make of all this? Well, as I’ve mentioned before, I think it’s legitimate to be concerned about where the economy is headed over the next year. But CNNMoney is guilty of some very sloppy reporting. The chart they show is worth discussing–and it may even turn out to show the direction of the S&P 500 over the next year–but it’s equally important to show that the recent “correlation” is probably nothing more than a coincidence.

Bad CNNMoney! No soup for you!