The National Association of Realtors (NAR) reported existing home sales for June yesterday (July 22). Notwithstanding the problematic of aspects of using "seasonally adjusted annualized rates," (as explained below) the reported result was slightly ahead of expectations, both Wall Street's and mine. However, beneath the optimism reflected in the headlines, the underlying data shows a continuation of the problematic trends that have been in place for about a year. Trends which reflect, in my opinion, a fundamentally unhealthy housing market.
The "seasonally adjusted annualized rate" - or SAAR - is a metric that is calculated by taking the data estimates, applying an opaque statistical calculus to the data and producing an annualized rate: NAR statistical methodology. The resulting number represents what the total sales for the year would be if that rate were maintained for 12 consecutive months. See the problem here?
Historically, June is the highest month seasonally for home sales, so today's SAAR number was supposed to be higher than May's SAAR. However, using a SAAR is a deceptive reporting tool because the number reported overstates the true rate of home sales over any calendar period. For instance, despite the month to month gain from May to June as reported, the SAAR has been negative year over year for the last 8 months (source: NAR, edits in red are mine):
As you can see from the graph above, existing home sales - even on a SAAR basis - have been in a serially declining trend every month since October 2013. The effect of the SAAR calculation, when sales are declining, is to overstate the true level of ongoing sales. Fortunately, the year-over-year comparison enables us to compare "flawed" apples to "flawed" apples. Thus, per the data table provided by the NAR, we can see that June 2014 SAAR is lower than the June 2013 SAAR. Again, this comparative trend has been in place for the last 8 months and I expect it to continue into the future.
The second problematic aspect to June's existing home sales report is the rising inventory. The narrative used by the housing industry and by Wall Street to explain declining sales is that unusually low inventory is keeping a restraint on buyers. I have argued in previous articles that this is a faulty explanation. Inventory is indeed rising (see the data table link above). However, the inventory reported in June 2014 is 6.5% higher than that of June 2013, yet sales declined year over year. In fact, the NAR's reported housing inventory was quite bit lower than the current inventory during the entire June-October 2013 period, yet the reported home sales (SAAR basis) in each of those months was higher than for June 2014. This circumstance particularly underscores the flaw in the "low inventory" narrative and further reinforces my view that the June existing home sales report reflects fundamental weakness in the housing market.
Finally, the most important factor in judging the health of the housing market is demand. First-time buyers represented just 28% of sales per the NAR. This is significantly below the long-term average of 40% for the first-time buyer segment. With 30-year fixed mortgage rates lower than a year ago, the problem with first-time buyer demand isn't the relative cost of a mortgage or a lack of selection, the problem is this (source: Acting-Man.com):
As you can see, the average household income, after adjusting for inflation, has been declining since 2007. In other words the ability for potential homebuyers to find jobs that pay enough to buy a home has been declining for the last 7 years. In my view, this is by far the foremost fundamental problem endemic to both the housing market and the overall economy. Until this factor reverses, once the investment buyer/flipper demand deteriorates to historical norms, the risk of another housing market collapse grows by the month. This is especially the case given that the Fed's support of the mortgage market is fading with the QE taper.
With a detailed analysis of the existing home sales data as presented above, I continue to urge that investors - especially those investors with the fiduciary duty of investing on behalf of clients - reduce or eliminate their exposure to homebuilder stocks. Since peaking this year on February 27, the Dow Jones Home Construction Index has declined 7.4% through June 22. In that same period of time, the S&P 500 has risen 7%, setting numerous all-time high records in the process. This negative divergence by the homebuilders from the rest of the market is stunning, especially given that mortgage rates have been declining since early March. Clearly the stock market is sending a signal that is consistent with my view of the housing market. Please see previous articles for my favorite homebuilder short-sell ideas.
Disclosure: The author is short DHI, RYL, KBH. 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.