It's not the one point decline in the Housing Market Index that worries me, but the why and the how the index declined. I think the component measures of this index say a lot about the real state of housing inclusive of smaller non-public builders. As far as the public companies go, I continue to see those firms gaining market share due to their capital advantage and crisis survival, where smaller builders failed. Still, even the larger builders face some negative fallout from the crisis and that is also discussed herein.
The National Association of Homebuilders (NAHB) reported its Housing Market Index (HMI) for the month of February on Tuesday. The HMI declined by a point to a mark of 46, down from 47 in January. Economists were looking for another increase in the recently improving trend that would have taken the index to a mark of 48 this month. The NAHB attributed the softness to the usual suspects, an uncertain employment situation and constraints to consumer borrowing. Obviously, that second factor is for the industry's own good and the result of the excesses of the financial crisis and real estate collapse.
However, the NAHB added a couple new issues to the spectrum of challenges facing homebuilders. The organization indicated that rising materials costs and a labor shortage in construction were working against recovery. The labor issue was a topic that came up during the presentation by Toll Brothers (TOL) at the Emerald Groundhog Day Investment Forum, which I was privileged to attend this year in Philadelphia. Construction shed jobs measuring in millions through the industry purge post real estate collapse, but it should be luring manual laborers back as it regains steam. Still, many of those former construction workers will have developed new skills and found other work by this point, and that's the issue the industry must confront now. It pushes the cost of labor higher, though both higher materials costs and labor are also the result of housing demand in this case, and that's a good thing.
What troubles me about the HMI this month are the component indexes, which continued to illustrate a difficult truth. The NAHB offers measures of the industry's current sales conditions, forward sales expectations and traffic of prospective buyers. While both the current sales conditions metric (down 1 to 51) and the forward sales expectations read (up 1 to 50) marked ground above the break-even threshold of 50, the real measure of actual prospective buyer traffic remained deeply underwater. With the traffic mark falling by four points to a level of 32, it represents a sad state of affairs that actually deteriorated in February. Expectations can be built on what builders are reading here and elsewhere about the housing recovery, but prospective buyer traffic is a true measure of actual activity, and it says a lot about the state of housing.
What it tells us is that the many small builders still being surveyed by the NAHB remain troubled due to a lack of access to capital and their relative inability to compete in terms of pricing and marketing. This is the reason why this recovery is so bifurcated, with the surviving large public builders gathering up massive market share from the purge of the disease stricken little guys. That said, the news of the overall index slippage still harmed housing stocks broadly Tuesday, with many major builders seeing share price decline.
Builder & Ticker
SPDR S&P Homebuilders (XHB)
D.R. Horton (DHI)
KB Home (KBH)
Beazer Homes (BZH)
Lennar Homes (LEN)
Of this group, KB Home likely benefited from the appearance of Weyerhaeuser's (WY) CEO on CNBC Tuesday, and the company's continued enthusiasm about its strongly improving California market. KBH has serious west coast exposure. The NAHB likewise had some good news to report on a regional basis for the West Coast. The regional metric for the West showed a four point uptick to a reading of 55. The Northeast measure was up three points to 39, but the Midwest and South regions both deteriorated by two points to 48 and 47, respectively.
Toll Brothers was down slightly ahead of its later reported earnings disappointment, but readers of this column should have been prepared for that given our expression of concern yesterday regarding visibility into the current result for TOL (see page 2). Our report linked here, offers insight into the rest of the week for real estate as well.
The HMI data reminds us that this recovery is not all encompassing, with varying degrees of activity by region and by industry player. The change in industry shares on such a small adjustment also tells us that much of the good news is priced in to homebuilder shares, making them especially sensitive to bad news.