Homebuilders Are Happy - Should They Be?

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 |  Includes: BAC, MORT, MTG, PHM, TOL, WFC, XHB
by: Markos Kaminis

Summary

A measure of homebuilder sentiment showed improvement Monday for the third consecutive month, with the index measure now sitting at its highest level since January.

Housing relative stocks across the builders, lenders and ancillary businesses are all significantly higher as a result.

But I wonder if homebuilders are right to be so joyful, considering their own reporting of the details and the expectations for interest rates and uncertainty about geopolitics and economies.

The National Association of Homebuilders (NAHB) reported its Housing Market Index (HMI) Monday. Based on the data, homebuilders are happier, but should they be?

The HMI improved 2 full points this August to a reading of 55.0, from the unrevised 53.0 mark for July. It was a better result than economists expected, with the consensus forecast set for 53.0. Anything above 50.0 indicates more builders view conditions good than poor. One positive note is that this reading has now improved for three consecutive months, and it currently rests at its highest level since January.

All three component metrics gained, but the devil is in the details. The index gauging current sales conditions improved 2 points to a reading of 58.0, which is a positive enough reflection on current sales activity. The index measuring builder expectations for six months forward also improved 2 points to a reading of 65, which is even better. However, the gauge measuring actual buyer traffic, though improved by 3 points, still sat below 50 at 42. So just what are builders telling us?

Remember, this is a sentiment measure, so they're simply telling us how things feel, but this has to be based on numbers that they're seeing and prospective things for the forward outlook. But when they are asked to comment on foot traffic, it seems like the figure is always under par. The reasons builders seem to constantly note for their discontent is tight credit conditions for potential buyers and their own labor shortages, as well as finished lot shortages in this latest report. The credit issue may actually be about to change in my opinion, though it would be paradoxical considering that mortgage rates are expected to rise. This is the topic of my next real estate relative article, so consider following my column to be notified of it.

Anyway, it has always been a concern of mine that actual foot traffic has been below par since the HMI broke above 50 after real estate started on its way toward recovery. It leads me to believe that homebuilders are generally optimistic people, especially given the other fact that the forward outlook figure seems to always be above all others, or at least when markets are improving.

This sentiment measure includes many builders, both large and small, and may not be an accurate measure of an industry that has undergone significant consolidation as a result of the crisis. Builders who went under, had their land and other assets acquired by other builders. And just like there is a shortage of labor because many construction workers found other lines of work, many builders have probably moved on as well, or downsized. So, consolidation in the industry may mean that the true perspective is really only understood by a small percentage of the group.

Why are builders so enthused anyway, especially considering the fact that the Fed expects to start raising the Fed Funds Rate next year? Before the latest geopolitical crisis in Ukraine, interest rates had been heading higher on expectations for the end of asset purchases and a turn in the direction of the Fed toward rate hikes. One would expect that if and when this latest flight to quality ends, and hopefully it will end, capital will flow out of U.S. Treasuries and interest rates will start rising again. That's a negative factor for housing, considering it will raise the cost of home ownership.

Housing Relative Stock

08-18-14

SPDR S&P Homebuilders (NYSE: XHB)

+1.8%

PulteGroup (NYSE: PHM)

+2.8%

Toll Brothers (NYSE: TOL)

+1.7%

MGIC Investment (NYSE: MTG)

+3.1%

Bank of America (NYSE: BAC)

+1.5%

Wells Fargo (NYSE: WFC)

+1.0%

Market Vectors Mortgage REIT (NYSE: MORT)

+0.0%

Click to enlarge

Monday's price action sure shows housing joy today. Obviously, positives do exist to give confidence to homebuilders and investors in these stocks. The labor market is certainly improving, however changed it may be due to the financial crisis. Fewer and fewer Americans are filing for unemployment insurance, so while the long-term unemployed figures and Americans on welfare programs remain too high, at least we've stabilized and jobs are being created for the employable and those seeking jobs. Economic growth is also there, as evidenced by recently reported GDP growth. Finally, home ownership, while becoming more costly is still significantly more affordable than in recent history before the crisis. And many Americans are coming out of distressed financial situations ready to rebuild their lives.

Of the four regions reported on, the Northeast is the laggard, with a reading of 38, up 2 points since July. The Midwest, a hard hit economy with a significant population base, but now with new growth characteristics because of the domestic energy boom, gained 7 points in August, to 55. The West and South, two growing population centers, rose 4 points and 1 point respectively, to marks of 56 and 52, respectively.

It's just difficult to say whether the housing market is ready for higher rates yet. It's also difficult to predict how the geopolitical crisis will affect the European economy and potentially the U.S. economy, and housing. So, I wonder if the homebuilders are justified in their state of joy expressed on Monday.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.