When you develop your opinions on the basis of weak evidence, you will have difficulty interpreting subsequent information that contradicts these opinions, even if this new information is obviously more accurate - Nassim Taleb
The homebuilder stocks reacted quite bullishly to the release of the Case Shiller home price index and the housing permits data this morning. Based on a more thorough analysis of recently released data that is more comprehensive and revealing than today's data, the action today is likely a "one day wonder, short-cover" bounce and should be sold and/or sold short.
First, let's dispel any significance attached to today's housing market reports. The Case-Shiller (C-S) home price index showed a big price gain that is based on year over year comparisons. There is no doubt that prices are higher this year than last. But the C-S data is a lagging index based on a trailing 3-month moving average calculation. This means that the data released today for September is actually based on an average observation of prices that occurred in the middle of the summer. Not only have month to month prices been declining for both existing and new homes (please see my recent articles on new and existing home sales on Seeking Alpha which show the actual price data), but the C-S index is based on a limited data sample. Please see my article which explains why the C-S is flawed and is not a good measure of what prices are doing currently in the housing market.
Secondarily affecting the homebuilder stock bounce today was the release of housing starts. The problem here is that, because of the Government shutdown, the Census Bureau was only able to provide new building permits. To interpret this data as "bullish" is problematic. First, a builder will file a permit to have it in place in case it decides to start a new home or apartment building. It does not necessarily translate directly into an actual building that can be sold or rented to an end user. Furthermore, if you peruse through the data in the link I provided, you'll see that permits for single family homes were basically unchanged from the previous month and that most of the increase was for multi-family apartment buildings. Again, a permit does not translate necessarily into something that will make money and thus the data is being incorrectly interpreted by the market as "bullish."
With that explanation as the context for why I believe that today's data is misleading the housing market bulls, let's look at some recent data which reflects what's happening currently in the housing market and why it appears as if the housing market is quickly going into a decline.
To being with - and a fact that underscores my point about the difference between using permits and actual starts in judging the housing market - the National Association of Homebuilders released its monthly "confidence" index for November last week and it dropped to a 5-month low, missing consensus expectations for the 3rd month in a row. As my link discusses, the previous reading for October was revised lower, which is why the headline reports suggested that confidence levels were unchanged. However, until the revision was released, the market was assuming a higher level of "confidence" than was actually the case. This suggests that market expectations are too high right now.
One more point about the NAHB confidence index, this metric is based primarily on "foot traffic." As with building permits, "foot traffic" does not necessarily translate into a real economic transaction. As this report from Credit Suisse (sourced from Zerohedge.com) details, October housing traffic was the weakest in two years using "broad-based" measures. In addition prices are moderating and it's taking a longer time to sell homes. This is consistent with the data from both new and existing home sales that I have presented in recent Seeking Alpha articles and reinforces my view that the housing market is declining again.
Finally, one last data point in further support of my bearish view, the National Association of Realtors Pending Home Sales report was released yesterday, showing yet another sequential month to month decline in pending homes sales. As my report on this last month demonstrated, this metric is a lagging indicator and the report released today for October would actually reflect contract signings as far back as July. What this means is that the true condition of the housing market was much weaker than was being reported at the time by the media and the data providers. As such, I believe that the homebuilder stocks reflect market valuations which are too high based on falsely-predicated expectations.
The biggest factor not being reflected in Wall Street and, more importantly in homebuilder stock prices, is the potential "black swan" embedded in the impending wave of home equity loan resets that starts to hit homeowners and big banks - primarily Wells Fargo (NYSE:WFC), Bank of America (NYSE:BAC), Citigroup (NYSE:C) and JP Morgan (NYSE:JPM) - in January.
I think we have all lost track of the huge amount of home equity loans (HELOCS) taken out by borrowers during the housing bubble. Now it turns out the largest chunk of those loans still outstanding will begin to convert into floating-rate, amortizing mortgages that will significantly affect the monthly mortgage payment obligations of the homeowners who have them.
Based on data sourced from the Fed, there's $652 billion in HELOCS currently outstanding, with the four biggest banks listed above holding $319 billion. Data also shows that the delinquency rate on HELOCS is rising and the chief economist of the credit agency Equifax recently stated that the coming reset of these HELOCS is a "pending wave of disaster." In other words, starting in January when the HELOC reset wave begins, we'll likely start to see the rate of mortgage defaults and housing foreclosures begin to spike higher, reminiscent of start of the housing market collapse just a few years ago.
I plan on covering this more thoroughly as the situation develops and this could well be a "black swan" development that hits the housing market and something which is not being factored in by the stock prices of the homebuilders. Given my view, I am recommending that existing holders of the homebuilders should, at the very least, cut down their positions. In fact, I would go as far as suggesting that based on my analysis, and the data backing it up, portfolio managers have a fiduciary duty to cut their exposure to the sector. I recommended shorting DR Horton (NYSE:DHI) at the end of January and I'm up 24% on my cost-basis on this position. I recently recommended shorting KB Homes (NYSE:KBH) and with today's bounce in the homebuilders I'm slightly green on the position and plan on adding to my short position today, most likely by shorting December near-money calls which will give me some upfront premium while reducing my risk exposure in the event that this current bounce lasts a few more days. Finally, I am confident that the data that will be released in the coming months will vindicate my view and short positions.