- Mortgage purchase applications continue to decline at double-digit rates.
- Despite historically low mortgage rates sales volume is declining.
- Toll Brothers revised its 2014 guidance lower.
Despite the use of seasonal adjustments and monthly data that is expressed in terms of an "annualized rate" every month, the housing data being reported continues to support the bearish view of the housing market. In addition, the fact that Toll Brothers (NYSE:TOL) stock dropped 5% today (September 3) despite reporting a doubling of its net income reflects the fact that the expectations built into the homebuilder stock prices are too high.
The Mortgage Bankers Association released its weekly mortgage applications survey today. The Purchase Index (actual, not "adjusted") declined 4% from last week and 12% from the same week a year ago. This is despite another weekly decline the interest rate for the 30-yr fixed-rate mortgage. The graph below (source: Confounded Interest) shows the serial decline in applications for mortgages used to purchase homes over the last year:
If applications for purchase mortgages are slowing down like this, it means that housing sales are slowing down. This dynamic is exacerbated for the homebuilder companies because 93% of all new home buyers use a mortgage to make their purchase.
What is particularly notable about the decline in mortgage applications is the fact that this is occurring despite the move in mortgage rates to their lowest level in a year. The two graphs below show 30-yr fixed-rate mortgage rates and the monthly volume of new home sales over the last 10 years (source: St. Louis Fed, edits in red are mine):
As you can see from a comparison of the two graphs, new home sales have barely bounced off their 2010 lows and have been trending sideways despite the secular movement of mortgage rates to all-time lows (the graph for existing home sales is highly correlated with the new home sales graph; I'm using new homes sales because it applies to my trading/investing recommendations for homebuilder stocks). If historically low interest rates cannot stimulate a big recovery in interest rates, it tells me that something is fundamentally wrong with the housing market.
Further supporting my housing market thesis was the market's response to the release of Toll Brother's quarterly earnings. TOL reported a doubling of its net income (TOL 8-K filing) and a 36% increase in deliveries year over year. Despite these impressive results, TOL's stock plunged nearly 5% on volume that was four times the stock's 3 month daily average volume. The "culprit" was a 6% decline in contract signings for the quarter. In addition, the Company revised lower its guidance on total deliveries for the year. TOL's CEO reported in an interview on CNBC that the housing market has been slow to rebound. TOL's quarterly results and the CEO's remarks thus further confirm my housing market thesis.
Given the decline in both TOL and the Dow Jones Home Construction Index (DJUSHB), which was down nearly 3% today, I continue to believe that unrealistically high expectations are built into the market caps of the homebuilder stocks. I have been pounding the table with a "sell/short" recommendation on this sector since the end of January 2013. The DJUSHB has dropped over 13% since then despite the 21% gain in the S&P 500 over the same time period. I also believe that if/when the SPX rolls over and goes into bear market mode, it will exert particularly brutal downward force on homebuilder stock prices.
Based on this view, I continue to be short DR Horton (NYSE:DHI), KB Home (NYSE:KBH) and Ryland (NYSE:RYL). I also like short-sell plays in TOL, Pulte (NYSE:PHM), Lennar (NYSE:LEN) and Beazer (NYSE:BZH). Most of these stocks are trading at price/earnings ratios that are significantly higher than their P/Es at the peak of the housing market in mid-2005-2006. Yet, per the graph above, current sales volume for new homes is less than 1/3 of the peak volume at the end of 2005. This is a sector in which I believe not many analytic "eyeballs" are paying attention to the fundamental trends. Because of this I would argue that shorting homebuilder stocks offers "alpha"-derived returns.