Tops and Bottoms: Reflections and Predictions

The day before the private equity monster Blackstone's (BX) IPO, I wrote:

If there was a huge upside to these folks, I do not think they would be cashing out and subjecting themselves to all the increased scrutiny a public company goes, through.

I will stay away . . .

Shares, after hitting $37.98 immediately after they began trading, have slowly receded and now sit at $29.92 for a 21% decrease in four trading days. Do I have a crystal ball? No. This one was easy - when billionaires decide to sell we common folks "a taste," it is usually only because they see more upside in selling it to us than keeping it for themselves.

Carl Icahn, in an interview on CNBC on Wednesday, said when asked about private equity "easy money and cheap deals are going away and this will severely impact earnings at private equity." When you add the specter of a tax increase from 15% to 35% on these entities, it is no wonder they are racing to cash in before we all realize they are due to earn much less in the immediate future. This probably also explains why the other private equity IPO, Fortress Investment Group (FIG) which began trading at $31, now sits at $23.25, a 25% loss.

In 1999 and 2000, everywhere you went the talk was about the Nasdaq, tech stocks and the internet. The level of people who made a living "day trading" from their bedrooms skyrocketed. Shares of companies like Yahoo! (YHOO), Dell (DELL), EMC (EMC), and Cisco (CSCO), were all household names that traded with valuations in the stratosphere. When your mailman, paperboy, and the 16-year-old kid bagging your groceries are talking about the next tech IPO, and how it should double the first day, you need to take a step back. When they are throwing around terms like "click through," "routers," EBITDA, and have no idea what those mean, be very afraid. Not long after, the market began a two and a half year slide that the Nasdaq has still not recovered from.

In late 2003, people had finally had it with the stock market and accounting shenanigans and began flooding the real estate market with money. Stock valuations, despite an improving economy and growing earnings hit low levels not seen in a long time. The same mailman, paperboy and grocery bagger were all now talking about how stocks are a losing game and that the market was "rigged." This, of course, signaled the bottom of the market and stocks have climbed steadily ever since.

In early 2006, the number of real state agents in the U.S. hit an all time high. Filled with sugar plum visions of real estate riches, potential agent flooded the market to get in on the action. This, of course, signaled the top of the market and real estate values (and the number of active agents) have plummeted since.

So where are we at today? Housing. It has to be near a bottom. I cannot pick up a newspaper, watch TV or go anywhere with hearing about the "awful" real estate market. On Wednesday, I was in BJ's (BJ), and heard a conversation between a 70-year-old woman who I was behind in line and the kid at the checkout. They, of course, were chatting about housing as he rang up her groceries and throwing around terms like "subprime mortgage meltdown" and "foreclosure rate." When it was my turn to check out, I asked "what is a subprime mortgage?" The reply came with a look that could only imply I was quite possibly to dumbest person on the face of the earth. He said "it's a mortgage that is not prime."

Right, smells like a bottom to me.

Is it today, tomorrow, or next month? Who knows, but it is near. How to play it? Home builders are a tough one. Valuing individual companies gets into a lot of guesswork based on the value of their landholding and the demographics of the region in which they do business. Also, they may make a sale today that gets canceled in three months, that causes an earnings outlook revision.

If investing here, I would look at the iShares Dow Jones U.S. Home Construction ETF (ITB) that began trading in May 2006 (another sign of the top), and is currently down 35% since it started. The index is a free-float adjusted market capitalization-weighted index.

It measures the performance of the home construction sector of the United States equity market and includes companies that are constructors of residential homes, including manufacturers of mobile and pre-fabricated homes. It will give you exposure to the whole housing market and avoid the individual companies' potential pitfalls.

Comments

[Paul Meisel:]

I agree with much of your commentary but would choose a different investment strategy. As the market bottoms and recovers, the index will still include some of the weaker stocks that will underperform or perhaps not make it.

I would do some homework (well, I have, but that's another story) on who the strongest players are and stick to 3 or 4 of them.... when it's time.... which I still don't think is yet, but it's getting close.

I wonder what the "new realtor" and "renewing realtor" license count is these days?

2007 Jun 28 09:15 AM

[benesposito:]

Your logic about the contrarian argument will undoubtedly one day prove true. However, it will not neccessarily help you call a bottom.

"Right . . . smells like a bottom to me.

Is it today? Tomorrow? Next month? Who knows, but it is near."

I happen to think your argument about the subprime talk would be more akin to saying something like "stay out of fiber optic companies, but invest in other tech stocks" back in the .dom bubble.

I read recently that a poll conducted by the Boston Consulting Group showed 55 percent of Americans believe they could sell their house for more money now than a year ago.

Yet the trend shows increasing inventories of homes, and fewer potential buyers (mortgages becoming harder to obtain). While at the same time huge numbers of ARM loans are resetting.

So when the polls reflect the reality, and people all feel housing is a disaster (as it is for the builder's right now), then your logic might call for the actual bottom. In a year or two.

However, that said, your suggested investments get their value based upon homes being built, and if people thikning housing is a disaster, it may be longer from that contrarian indicator until the point when construction would actually pick up.

2007 Jun 28 11:03 AM

[Bob K.:]

Real estate tops and bottoms are not like stock tops and bottoms, they are much more elongated. So no need to rush in yet. You will still make plenty of money if you wait to buy housing stocks until the inventory levels fall, and the median price rises, and the number of sales rises. All three. If not you are sitting on dead money. You can now make more money with the ETF symbol SRS (even after its nice run). The downturn has a way to go, commercial real estate asset writedowns are next on the list.

2007 Jun 28 11:12 AM

[jbs:]

We may be near a bottom but extensive news coverage about subprime mortgages isn't enough to arrive at that conclusion. News coverage is only one signal that a bottom is approaching.

These stocks are still being sold. When they report disappointing earnings and the stocks cease to decline further, that's when I'll get interested -- when the sellers are gone.

2007 Jun 28 10:24 PM

[Tom B:]

Housing is ailing because housing prices have risen faster than incomes. With the job outlook being much poorer than BLS suggests, everyone who can afford an shiny new home has one. I would be leery of diving into real estate-related stocks until we see signs the REAL economy is improving: more new plants opening; fewer financial shell-game operations (stock buy backs and the like).

2007 Jun 29 09:17 AM

[Fred W:]

We are merely seeing the tip of the iceberg. The real pain is coming--it will be a slow bleed that we will all look back at and say "why didn't we see the forest for the trees?"
75% of the small home builders are going to file chapter 11 if they haven't already. The big guys are suffering with massive write downs and their most talented people running for the door--no profits means no real income for the skillful few who actually make the money for the large tract builders...thus the talent is/will jump ship.
Oversight is returning to the mortgage business and therefore the buyer pool will continue to shrink--all of the ignorant buyers that really "drove" prices will no longer be able to get a loan--no "traffic" means that the savvy buyers who can still qualify for a loan will wait to see how prices trend--plenty of nice rentals available.

2007 Jul 02 11:17 AM