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What the Homebuilders Are Telling Us

by: Timothy Charles August 24, 2008 | about stocks: ITB / IYR / UDN / UUP / XHB    

Timothy Charles

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It's no secret that the housing market is weak. Sales are coming but at greatly reduced prices. Builders continue to put up the "million dollar castles" in cities nearby which has confused me. Financing is tough these days though available at much higher rates. Crude prices are lower but the price of unleaded has not completely unraveled... at least not yet. The unemployment rate has been moving higher and job creation is basically nil with my own models showing that job creation at its weakest since June of 2003. Lastly, the realtors of today look like the stockbrokers of the bubble era - they went along for the ride and now don't know what to do when the "ride" blows out a tire. So with all of these negatives in play, why are we seeing the homebuilders rally?

Now this is no ordinary rally. There have been squeezes in the past but those squeezes were isolated and not accompanied by other securities - in this current case, the greenback. The bears have been out on the dollar but moreso of late on the housing market. The reasoning behind such has merit but the homebuilders have continued to climb. One of my trader friends, who has been doing this for 30 years, often says that at market lows, the next leaders are born. We saw that in 2002 when the basic materials were the first off the lows. We saw that in the late '90s with the techs accelerating to the upside. Could 2008's low candidates, the financials and the homebuilders in this case, be the next leadership? Could they be telling us that perhaps credit conditions are now in place for housing to stop falling?

click to enlarge

That is a strong leap in some cases. One could say that the homebuilders and the financials were so beaten up that a bounce was inevitable. For the financials, I don't necessarily doubt that, and in using the BKX, they really have not reclaimed levels of last year. The homebuilders on the other hand, using the HGX, have reclaimed a trading range and have bottomed in a similar location to the lows of 2003. If they are truly moving up, and have seen the lows, this could market stability. The last true time that housing had stability was in 2005. The market probably was much more than stable at that point but in this case, I argue steady to rising prices. 2006/07 were periods of flat to down though the statistics won't bear that out. 2008 has been "tough" for the lack of a better word. Thus, stability has not existed for 3 years now going into year four, which is only four months away.

A while back, in trying to understand the real estate market, I did analysis of the new home sales data to the existing home sales data for the period during the late 80s into the 90s. Now I cannot find it anywhere but I do remember a few things from the research. First, the new home sales data bounced first followed by existing home sales data about 2 years later. This makes sense in many ways in that the new homes went into the existing pile and took a few years to work off in terms of inventory.

Meanwhile, homebuilding just was not strong during this period and overall inventory levels came down. Comparing that to the current period, homebuilders have been steadily cutting back on building and playing defense if you will. If the homebuilders index is correct, perhaps we are now at that point where the new homes sales data stabilizes while the existing takes a few years to work off the slack? So what we have here is one index telling us perhaps what is going to happen down the road.

Now there are a few things that actually support a rally. First, the Fed is maintaining an easy monetary policy stance - I estimate about 195bps at this point which is well off the lows of the Greenspan times during 2003 but still pretty easy when inflation and commodities are rising. In addition, long rates are not terribly high and only those with good credit are getting loans. Now one may look at this as a problem - I see it as a way to stabilize the market. If those who have good credit and 20% down to buy a home are the owners, the probabilities of foreclosing on these folk is much lower. If the foreclosures slow to a crawl, then the focus remains on the existing inventory which means that the price that it sells for, will be not at fire sale prices but rather something comparable to the given area.

Another factor to consider is the dollar. Now, I am not advocating that the dollar low is in. One can never call a low in a currency, in my opinion, for the long term. However, I am bullish on the dollar now and could see it trading another 3-5% higher from here. That means that dollar assets might be in vogue which could attract international flows into US domestic assets. If those assets include credit instruments, then the credit markets will stabilize which also creates better loan conditions for the banks and more buyers for the real estate market.

So what am I saying? I argue that the homebuilders have bottomed. But, I don't know if the actual housing market is going to rise anytime soon. The CME Housing futures have stabilized over the past few months but they are not particularly liquid so using them perhaps is not a strong support for the real estate market. My own models show that we are in the third wave down for housing right now (we had three rising ones in the earlier part of the decade). We have bounced each time for this level but the previous two times were not accompanied by the homebuilders. Thus, we have the CME futures, the homebuilders and my own indicator all at extremes or turning. The market is making a bet and that bet is that real estate is stabilizing.

Question is... is it a good bet?

Disclosure: Long the Dollar Index.

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This article has 16 comments:

  •  
    Aug 24 03:36 PM
    You and the market are probably wrong. The backlog of unsold homes is the price lid on new homes, it is not going up, but down. Good try, but no cigar either.
    Reply
  •  
    Aug 24 04:13 PM
    Look at insider sales (TOLL) for instance and re-think your story...
    Reply
  •  
    Aug 24 04:42 PM
    An opinion at this point of the game has no validity. With unemployment, credit card debt coming crisis, heating cost this winter, gasoline prices that will rise again will a play a major factor in the housing market. If everything stays realativly stable then I say we have the forming of a bottom and would agree with you. If everything goes negative then we have never seen the likes of what is to come. The great depression talked about in future generations will the the one we will live through
    Reply
  •  
    Aug 24 11:46 PM
    Sounds like wishful thinking. A few weeks ago a bottom was being called in financials but that sentiment has quickly disappeared. Even if a bottom is in, any major recovery is years away.
    Reply
  •  
    Aug 25 12:33 AM
    The market is digesting the sales reports from the summer. Home sales drop after Labor Day when children need to be registered in schools and do not pick up again until the end of the school year. Add in the cool weather pattern of La Nina with a cold winter with new homebuilders being forced to expend more of their own money to heat their new homes which will be sitting vacant and things are looking bleak. Meanwhile, municipalities, strapped for cash, will be raising local property tax rates, followed by a wallop of insurance premiums rebounding from the last five years when the industry was underpricing everything. Every potential homebuyer and speculator is sitting and waiting for the spring when home sellers will be desperate. Hot market real estate attorneys, title companies and settlement agencies are sitting at their computers playing solitaire waiting for the phone to ring. Real estate brokers are watching their Mercedes get reposessed. It is going to be a cruel, cruel winter as homebuyers try and save as much as they can for the upcoming inevitable mortgage rate increase by next summer. I would not gamble my worst enemy's money on a homebuilder ETF. It is strictly an eyes-glued-to-the-term... trader game, and I spend enough time in front of the computer as it is.
    Reply
  •  
    Aug 25 08:08 AM
    If it walks like a duck, sounds like a duck, looks like a duck.... it has to be a duck !

    This is a down market and will not come back untill there is a much bigger implosion. The banks are so scared they do not want to lend any money. Look at the rates on forward money that tell the whole story.

    We are far from the bottom... very far.
    Reply
  •  
    Aug 25 09:31 AM
    When I see on the evening news stories of holders of large inventories of unsold/unsalable homes bulldozing them to reduce that inventory, then I will consider the possibility that housing has bottomed. The current unsold inventories eclipse previous historical comparisons, making previous historical comparisons a poor yardstick to measure things by.
    Reply
  •  
    Aug 25 02:09 PM
    While everyone here is probably right about the real estate market, they are probably wrong about (homebuilder) stocks. The two are not always correlated and the author raises some credible "technical" points about these sector stocks. As a longtime bear on homebuilders, I am betting on the stocks recovering despite their "property" values declining. At least for a substantial retracement - which is still worth the long trade.

    Food for thought!
    Reply
  •  
    Aug 25 07:51 PM
    What do they call a former homebuilder? Yeah, waiter.
    Reply
  •  
    Aug 25 09:13 PM
    Tim, you need to find that lost sales data from the 80s and 90s you did the analysis on. It probably didn't conclude what you think it did. There is no way real estate is stabilizing.
    Reply
  •  
    Aug 26 11:47 AM
    Realizing everyone has stated valid points, heres another aspect to ponder...
    The Internet. People are now able to use the interent to search rates, new mortgage programs, stocks etc...
    With that said i believe the internet is large contributing factor to our current "crisis". People are realizing that they can navigate their way through various internet sites, getting the "raw" truth about our current and what programs are available.
    I believe when the market stablizes we will see numbers drop by atleast 1/3. Refer to the book Freakeconomics, by S. Levitt. Makes sense.
    Reply
  •  
    Aug 26 12:42 PM
    Real estate is local. Prices are based on affordability and a premium for desirability.

    Places where average prices were 10 times average household incomes (california for one), the real estate will continue to fall at least until they reach whatever premium these places deserve as nice places to live. But in places where prices never went out of sight, they won't fall much either.

    That assumes constant interest rates. If rates go up, prices will fall everywhere because it decreases affordability.
    Reply
  •  
    Aug 27 05:14 PM
    Agree with the bears on this one, no way real estate decline has any end in sight. We are experiencing the plateau of sink or swim, and right now the water is still going out!
    Reply
  •  
    Aug 27 05:16 PM
    I've been in the real estate development business for years and have never seen any environment that looks a bad as this one does going forward. Everything is stacked against RE for at least the next three or more years. Interest rates? (check) raw material prices (check) inventory? (check) availability of credit? (check) I mean....wakeup!
    Reply
  •  
    Aug 27 05:18 PM
    I've been in the RE development business for about 40 years and have never seen an environment as stacked against a turnaround as this. A partial list; interest rates, inventory, raw material costs, demographics, credit availability.....I could go on and on....wake up bud, we ain't ever close to a "turnaround"...
    Reply
  •  
    Sep 10 11:18 PM
    I've been in the RE development business for about 100 years...
    wait a minute, I'm not dalerb... what am I doing!
    Reply
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