The National Association of Realtors (NAR) released its Pending Home Sales Index for March (PHSI) this morning (April 28). While the index bounced 3.4% to 97.4 from February's reading, it was down 8% from March 2013. Although the headline number reported appears positive for the housing market, a detailed analysis of the data shows that the market fundamentals continue to deteriorate. This idea is reflected by the fact that the Dow Jones Home Construction Index (DJUSHB) initially jumped 2.8% higher after the report was released, but 2 1/2 hours later has faded to unchanged on the day.
While the PHSI for March (data table) showed a 3.4% increase from February, the metric had been declining for 8 months in a row. Despite the month-to-month increase, the index registered an 8% drop from last March and a 12.1% plunge from its peak in June 2013 (keep in mind that the data are seasonally adjusted and annualized, enabling reasonable month-to-month comparisons, which are theoretically cleansed of seasonal data bias). Furthermore, on a year over year basis, all four regions showed declines, with the Midwest down 10.1% and the West down 11.1%. The report prompted the NAR Chief Economist, Lawrence Yun, to lower his outlook for home sales this year:
Although home sales are expected to trend up over the course of the year and into 2015, this year began on a weak note and total sales are unlikely to match the 2013 level. Existing-home sales are expected to total just over 4.9 million this year, below the nearly 5.1 million in 2013. (link at the top).
Based on the trends in home sales that I've been analyzing (see my previous Seeking Alpha articles), I would argue that this will not be the first time Mr. Yun revises his forward guidance lower. In fact, the index has increased from February to March for the last 5 years. Despite this, it is down over 23% from its peak in August 2005 and it has likely experienced nothing more than a "dead cat" bounce from the steep downtrend that began in June 2013:
As you can see from the graph, the PHSI is well below its peak from 2005 and, in my view, has experienced an expected bounce from the sharp decline in contract signings, which began last June.
As I've mentioned in previous articles, the biggest driver of existing home sales for the past two years has been the big investment buyer. With the big investment buyers beginning to drop out of the market (see previous articles for source links), in order for the market to sustain a recovery, it will require that the more "traditional" buyers replace the demand from investors. But as the mortgage application data shows, the more traditional buyer is fading quickly (graphs from The Wall St. Journal, edits in red are mine):
As you can see, the demand for new mortgages has plunged this year despite the fact that 30-yr mortgage rates have stabilized at a historically low level. Several analysts have attributed the decline in buying from the traditional demand cohorts (1st-timers and move-up buyers) to higher interest rates. But as the graph on the left above shows, 30-yr fixed rates are still 36% below their highs back in 2005. It is my view that the plunge in mortgage applications reflects the serially fundamental deterioration in the ability of the traditional home buyer to make a down payment and carry the costs of buying and owning a home despite the fact that interest rates are still at a historically low level.
If the traditional "organic" housing market demand component continues to deteriorate, I believe that the housing market will experience a repeat of the drop in sales volume and prices that we saw starting mid-2005, only this time from a lower overall level. If my view is correct, it implies that expectations for home sales going forward are too optimistic. It further implies that the stock values of the homebuilder stocks are too high.
I have been recommending selling and/or shorting the homebuilder stocks since the end of January 2013. Despite the fact that the S&P 500 is up nearly 25% since then, the DJUSHB is down 8.7% from my initial "sell" recommendation. I continue to recommend selling/shorting the builder stocks, leaving room to add to short positions when the sector spikes up, like early today. I am short D.R. Horton (NYSE:DHI), KB Home (NYSE:KBH) and Ryland (NYSE:RYL). I also like shorts in Lennar (NYSE:LEN), Pulte (NYSE:PHM), Beazer (NYSE:BZH) and Toll Brothers (NYSE:TOL).
Disclosure: I am short DHI, RYL, KBH. 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.