The Housing Market Lurches Lower

by: Dave Kranzler

The National Association of Realtors (NAR) reported its Pending Home Sales Index for July today. On a seasonally adjusted basis, pending home sales dropped 1.3% from June to July. The index is supposed to be a "leading indicator" of housing market activity and it measures contracts signed on existing homes for sale. You can read the press release here: NAR Pending Home Sales.

Even the chief economist for the NAR, Lawrence Yun, who has a reputation for putting a positive "spin" on any kind of negative data, admitted that higher interest rates are affecting sales. The truth is, the "seasonal adjustments" are supposed to "cleanse" the data of any variability associated with the fact that June historically has a higher rate of sales than July. In other words, the adjustments are designed to give an "apples to apples" comparison on a month to month basis. Thus, housing market hopefuls cannot point to the fact that July sales typically decline from June.

And the actual data is even worse. If you look at the unadjusted data - which you can access here: pending homes sales unadjusted data - you'll note that the index declined 8.5% from June to July. The index for the northeast literally fell off of a cliff, dropping 22.1%. It's one thing to say that higher interest rates have caused a slowdown in home sales, but those numbers reflect a market that is danger of crashing.

Let's see what the stock market is telling us. Here's a three-year daily chart of the Dow Jones US Home Construction Index (DJUSHB), which is considered a good leading indicator for the housing market:

(Click to enlarge)

As you can see, the DJUSHB has now fallen from its peak in May back to its August 2012 level. The index is now down (as I write this) 28.4% from its May 2013 peak of 550. I find it interesting that none of the financial media outlets ever refer to the housing stocks as being in a bear market, although technically that's what it is. You can also see that the standard momentum indicators - the RSI and the MACD - are well below their respective peaks. Both indicators are reflecting the fact that the selling in the homebuilder stocks greatly outnumbers the buying.

The DJUSHB plunged 2.4% yesterday, largely in correlation with the entire stock market and despite the drop interest rates. However, today the SPX and the Dow have bounced sharply from yesterday's sell-off but the DJUSHB is down another 1.2% as I write this. This confirms what the momentum indicators are reflecting and tells me that investors are working hard to unload their long positions in the homebuilder stocks. Furthermore, as a leading indicator of the direction of the housing market - the DJUSHB actually peaked in 2005 and bottomed in 2008, well ahead of the big decline and rebound in actual home sales - the housing stocks are telling me that the housing market, both new and existing home sales, is about to enter a serious decline.

The truth of the matter underlying the "dead cat" bounce in the housing market over the past 18 months is that since 2008 the Fed and the Obama Government spent a couple trillion dollars trying to revive the housing market. All they really accomplished was the transfer of a massive number of distressed homes from the big mortgage banks [JPMorgan (NYSE:JPM), Wells Fargo (NYSE:WFC) and Bank Of America (NYSE:BAC)], and from Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC), to some large private equity funds looking to speculate on housing and to individual buyers who got sucked into the momentum that was generated. The stimulus has now lost its effect and the housing market is headed back to an eventual lower bottom.

I recommend that anyone still long housing stocks should use every bounce as an opportunity to unload their positions. Aggressive players with a longer term view can use every bounce as an opportunity to short the homebuilders. My personal favorite to short is DR Horton (NYSE:DHI). I've been short DHI since late January. I also like shorts in Toll Brothers (NYSE:TOL), Centex (CTX), Ryland (NYSE:RYL), MDC Holdings (NYSE:MDC), Lennar (NYSE:LEN), and KB Home (NYSE:KBH). KBH is going to start to get buried in litigation from shoddy construction practices. If you have a strong stomach, a short in NVR (NYSE:NVR) can make a lot of money. The one caveat to shorting is that, if the Fed does decide it needs to add more QE as it has stated in previous policy statements, the homebuilders will likely experience a big bounce. You can use that bounce to really get short.

Disclosure: I am short DHI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.