May Existing Home Sales: Form Over Substance

by: Dave Kranzler


April to May increase was seasonal, at best.

Seven consecutive months of year-over-year declines.

Underlying "quality" of sales mix was poor.

Sell/Short today's bounce in homebuilder stocks.

Existing home sales for May were released today by the National Association of Realtors (NAR). While May showed an expected increase in sales over April, the year over year comparison showed a decline. An analysis of the data shows that the underlying "quality" of the sales mix was poor, indicating that the housing market is very unhealthy and probably headed much lower in the months ahead.

May existing home sales showed a 4.9% increase over April. However, from a pure seasonal standpoint, this should be expected as this graph shows (source:, edits in red are mine):

As you can see, May is seasonally the second strongest month of the year for home sales, and the pattern shows a typical increase over April. April to May 2013 showed a 3% increase. I would argue that today's report shows a statistically insignificant increase over April. Moreover, the fact stands that May was the seventh consecutive monthly decline in the year over year comparison. For instance, May 2014 sales declined 5% from May 2013 (the West was down 11.4%). In other words, today's existing home sales report for May does not necessarily translate into the conclusion that the housing market is once again trending higher.

Furthermore, mortgage purchase applications in April showed some consecutive week to week increases. Because it takes, on average per the NAR, 45 days to close a home purchase (existing homes sales are based on closings) right now, the bounce in mortgage applications from April is showing up in May existing home sales. However, based on several weeks of fairly large declines in May mortgage purchase applications, as I've detailed in a couple previous article, I expect June's existing home sales report to disappoint.

In addition to my view that May's reported existing home sales increase over April was statistically insignificant, it looks like the "quality" of the sales mix was poor. By this I mean that the distribution pattern of sales was skewed away from the all-important first-time buyer segment and more toward the all-cash buyer at the high-end of the market.

According to the NAR, the first-time buyer "continued to underperform," with 27% of the market. This was down from 29% in April. Historically, the first-time buyer segment has represented 40% of the market. It would appear that in one of the peak seasonal buying months, the most important demand component of the housing market continues to fade. In addition, distressed/foreclosure sales were just 11% of sales, down 18% from April. For the past two years, the distressed/investor segment of the market has been one of the driving forces behind sales volume and price increases. It would appear that this segment is fading as well.

This idea that the "quality" of May's sales data was weak is illustrated in the following two graphs from the NAR (edits are mine):

As you can see from the above graph, the existing home sales data was heavily skewed toward the high-end segment of the market. First time and investment buyers continue to drop away from the market. A healthy housing market can not be sustained by the sales of McMansions.

In addition, this graph shows the continued year over year decline in sales:

The data in this format eliminates seasonal noise and enables us to make inferences about the relative health of the housing market. In my view, seven consecutive months of declining sales on a year over year basis is indicative of a market that is, on the whole, contracting. Given that the first-time buyers are fading and that May's home sales overall were driven by high-end buyers, I expect that June's sales report could end up showing a significant downside surprise vs. expectations, unless flippers make one last push to get into the market before reality sets in.

Given my view of the housing market, I continue to pound the table on selling and short-selling the new homebuilder stocks. If the existing home sales market is contracting, it is my opinion that this dynamic is being transmitted to the market for new homes sales, where 93% of all buyers use a mortgage to make their purchase (68% used a mortgage for existing home sales in May per the NAR). Because of this, homebuilder stocks are overvalued.

As this graph shows, on Friday a decline in the homebuilders was punctuated by a big spike up in volume:

In contrast to Friday's trading action, today's bounce on the home sales report is fading and volume with less than two hours until the market close was well below the YTD averaged daily volume. To me this is non-confirmation that today's report was positive. Furthermore, since the beginning of March, the DJUSHB has been in a downtrend. This is a highly significant divergence from the S&P 500, which seems to hit new record highs every week. In other words, the action in the homebuilders, especially relative to the general stock market, reinforces the view that the housing market is unhealthy.

Based on the above analysis, I am short D.R. Horton (NYSE:DHI), KB Home (NYSE:KBH) and Ryland (NYSE:RYL). I am working on another short-sell idea that I think will do well. I also like shorts in Beazer (NYSE:BZH), Toll Brothers (NYSE:TOL), Pulte (NYSE:PHM) and Lennar (NYSE:LEN). I recommend using every short-term bounce higher in the DJUSHB, starting today, to establish or add to short positions. You can sell-short near and out of the money calls as a way to enter short positions to reduce your risk of upside volatility. You can sell out of the money covered puts to partially hedge short positions.

Disclosure: The author is short DHI, KBH, RYL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.