Housing Double Dips Offer Short Opportunities

Remember months ago when we warned about the housing double dip that portended for 2007?

No, the permabulls barked! They said economic growth would strengthen, employment was healthy and housing demand would resume.

Yeah, so, what does the one-year chart below depict then, a ski jump ramp?

No, it's the price movement of D.R. Horton's (DHI) shares over the last twelve months. Kind of looks like a double dip in progress to me...

DR Horton announced Tuesday that sales orders had fallen off a cliff in the quarter ended in March, falling 37%. DHI also said its cancellation rate was 32% above the historical range. Things are not really getting better either, according to DHI's CEO, who indicated that the seasonal spring selling season was not exhibiting its usual strength.

The housing ship is like the titanic, hard to turn. However, when it turns, it's hard to stop the turn as well. Housing is a huge industry, full of interrelated cogs and wheels that fail to operate properly when one is pulled from its position. So, subprime lending has effectively been shifted out of position, and lending across the spectrum of the mortgage industry has been impacted as a result.

The intensified regulatory scrutiny that followed increased defaults has raised the standards of mortgage brokers and lenders like Fremont General (FMT), Countrywide Financial (CFC), traditional savings & loans like IndyMac Bancorp (NDE), loan wholesalers, and the buyers of pooled mortgage backed securities like Fannie Mae (FNM) and Freddie Mac (FRE). So, when you hear people say the subprime suffering is contained, you have to ask, contained to where?

The chart below is that of Beazer Homes (BZH), a home builder that is suffering from the overall demand softness brought about by industry factors, and if you notice that steeper dip at the end, by company specific drivers.

The witch hunt that followed the sudden concern of politicians and federal agencies charged with protecting the unsuspecting public from predatory lending standards, showed up at Beazer's doorstep. The company is under investigation for the lending practices of one or more of its local managers. It would be nice if the Feds were more proactive and less reactionary, but that's life.

Lennar Corp. (LEN), another double dipper, had to bear some added embarrassment over and above that related to its stock weakness, when LEN's CEO recently had to eat his words. Stuart Miller uttered these infamous words in January, "As long as the current environment of strong employment, low interest rates and a healthy economy continues, Lennar will meet or exceed its 2006 earnings."

See that hump in LEN's one-year chart?

That statement probably helped the shares get there. Then, in late March, LEN's management pulled guidance for 2007 completely, citing a deteriorated industry environment. It's a little scary to see industry insiders get blindsided.

Even the chic of the publicly traded home builders have not been immune to the sector sickness. However, the chart for Toll Brothers (TOL) shares seems to show less of second slide than peers. Clearly, TOL's buyers are not going to be subprime borrowers, but if lending tightens across the board, and if the economy and/or stock market weaken, TOL seems likely to slip further as well.

So, where do you invest in the sector then? Heck, if I do not have to be long this group, I would not be long any names, but if I had to own a name, I would buy TOL on days the industry slides as a group or after it next reports a weak quarter.

For those of us with more freedom, I think you have to seek short opportunities still, especially within the subprime or better mortgage lenders, whose business portends to continue to suffer, despite their still solvent status. Some of the more traditional savings & loans or players within the Alt A space might offer more opportunity for downside surprise, but the subprime space should also get uglier as more loan payments reset. Double dippers may be pariah on the social scene, but they offer an opportunity for capital appreciation as short investments.