December new homes sales were released by the Census Bureau on Monday (Jan 27th). As I will lay out, December's report further confirms my thesis that the housing market is back in the bear market trend that started in mid-2005. Furthermore, as demonstrated by the degree that the Wall Street consensus forecast missed the actual result, the homebuilder stocks are overvalued based on market expectations that are way too high. All of the data I use comes from the report linked above unless noted otherwise.
Housing market sales data are reported as seasonally adjusted annualized rates (SAAR). This is important to note because the adjustments attempt to cleanse seasonality out of the data series for comparative purposes. A big part of my thesis for looking at the housing data incorporates analyzing the data on a month-to-month sequential basis for 2013 rather than looking at year over year comparisons. Headline reports and analysis are based on year over year comps. There is no question that the overall level of home sales was higher in 2013 than for 2012. But a definitive downtrend in the rate of sales over the course of 2013 shows that the market for new homes is headed lower.
The reported number of 414k missed the consensus expectation of 450k by 8% and was 7% below November's 445k. October and November numbers were both revised lower by 11k and 19k, respectively, or a combined 30k. Using the revised, more accurate data, the rate of decline in home sales from October to November was 3.9% and the rate of decline from November to December was 7%. As noted above, the numbers are theoretically "cleansed" of seasonal variability, which means the decline can be attributed to falling demand. My bet is that December's number will also be revised lower when next month's report is released, which means the drop in sales from November to December was probably even bigger than 7%.
In other words, it would appear based on these numbers that decline in home sales month to month could be accelerating. I will note that December's sales rate - again keep in mind that these seasonally adjusted - was nearly 10% below the sales rate reported in January 2013.
This decline in the sales rate for December is further confirmed by the inventory numbers in the report. The months supply of inventory reported for December spiked up to 5 from November's 4.7, a 6.4% increase. Moreover, December's inventory level was up 11.1% from that of December 2012. One point to note is that, if December's number is revised lower next month, the inventory number will be revised higher. The higher inventory reflects declining sales, which will put pressure on pricing and thus homebuilder profit margins.
Another aspect of the Census Bureau's new home sales data is that the numbers are based on contract signings as opposed to homes actually delivered. This distinction is important because home sale contracts are subject to cancellation, especially in the event that financing is unobtainable. As this report shows, roughly 93% of all new homes are financed with a mortgage.
The cancellation rate for new homes as reported by new home builders has been rising steadily this year. I have gone over of the details in previous articles. In general and on average, the cancellation rate has been around 25% the last few quarters (DR Horton reported a cancellation rate of 23% on Tuesday (Jan 28th). The key point here is that homebuilder stock market valuations are likely based on a level of assumed home sales that is overstated by 25%.
All of these factors, a declining sales rate, higher inventory and a rising cancellation rate indicate to me that the housing market is heading lower and its heading lower at an increasing rate of decline. Based on this, it is my view that the homebuilder stocks are significantly overvalued and should be sold and/or shorted. In fact, the homebuilder stocks - as represented by the Dow Jones New Construction Index (DJUSHB) - popped 5.4% on Tuesday and was up slightly again on Wednesday. I personally added to my short positions toward the end of the day on Tuesday. I am short DR Horton (DHI) - for which I will soon publish a review of its Q1 earnings report - and KB Homes (KBH). I also believe that Pulte (PHM), Lennar (LEN), Ryland (RYL) and Beazer (BZH) make good short-sale candidates.
One word of caution is that the high short interest in the homebuilders can lead to high volatility, especially on big up-days, as funds scramble to cover big short positions. Because of this, I always recommend leaving yourself plenty of capital with which to average up your entry price in building your short position. Finally, I believe it is likely that the downtrend in sales I see occurring will lead to data reports in 2014 that will show year over year comparative declines, which will lead to big downward "adjustments" in the prices of home builder stocks.