Is it time to short the homebuilders? I think so. There are simply too many headwinds for this sector, which has been a driving force in the economy in recent years. The homebuilders have responded accordingly, with companies such as PulteGroup (PHM), Lennar (LEN), and KB Homes (KBH) having fantastic runs through 2012 and into 2013.
LEN data by YCharts
As you can see, the homebuilders have done well, and have had small pullbacks recently. I think that stocks could be good shorts, but it would be wise to stay away from at the very least. As I said earlier, there are simply too many headwinds. There are many reasons that I'm not loving the homebuilders right now, here are just a few of the many reasons.
Rates are going to go up
This basically goes without saying, but judging by the reaction of many markets participants, they were completely unprepared for this to happen. From the moment when Chairman Bernanke spoke to Congress on May 22, the yield on the 10 year U.S. Treasury has been rising along with 30 year home mortgage rate and a falling stock market.
US 30 Year Mortgage Rate data by YCharts
That is a huge move, and the Fed hasn't even stopped QE3 yet. Another option that the Fed could choםse to pursue is to cut down on mortgage-backed securities while maintaining its Treasury purchases. There are many places where the housing market has either met or surpassed the pre-crisis highs. Some have suggested that the Fed could cut back on MBS purchases to avoid creating an asset bubble in the housing market. Any way this shakes out, rates will rise, there is no doubt about it. As rates continue to rise, homebuilders will continue to see downward pressure.
New Homes Aren't Being Built
Theט,re called homebuilders for a reason, they build homes. While this is a oversimplification of the business, it is mostly true. This is a chart of new home sales.
New homes simply are not being built, as the excess supply of homes and foreclosures had to be sold first before new homes could be built. Even with record low interest rates, low 30 year mortgages, and the Fed backing the housing market by purchasing $40 billion a month in MBSs. We have seen housing permits steadily rising, but new homes haven't been being sold. My worry would be that homebuilders have gone up alongside housing prices, even as new homes aren't being built. I believe that housing prices are artificially high as big institutional investors and the Fed have been inflating the price of housing, and homebuilders have gone up alongside this even as they haven't been building new homes. Don't get me wrong, I support what the Fed has been doing, but in this particular sector, with these particular stocks, I don't believe the current price is well above the fundamentals.
Housing Still Isn't Affordable
Housing still isn't affordable, in fact it is less affordable than it was before the crisis. The main driver of this is low wage growth and high unemployment, making housing unaffordable to many who lost jobs and haven't seen their wages rise.
This doesn't bode well for the future of homebuilding, and if housing isn't affordable then how can it grow? Institutional buying can't drive growth forever.
I haven't shorted any of the homebuilders yet, but I have started making my list. That list includes all of the stocks mentioned in this article. I think that any of these stocks, and even the Homebuilder ETF (XHB) would be a good short. I have one main concern with this trade, however. It is that the Fed has said that it is willing to increase the size of QE3, even amongst all the talk of it ending. Needless to say, I think that any short would get crushed if this happens. I believe that homebuilders have gotten way to far ahead of housing fundamentals, and will come back down soon.