Housing stocks have made a major turnaround in 2012. In December of 2011 I wrote an article stating it was time to jump on these housing stocks. Since that time they have had an unprecedented rally. The five stocks in question have bounced back from multi-year lows in short order on the news that housing sales are up. We are just now entering the summer selling and closing season. Most families move over the summer months to minimize the impact to their children's school attendance.
We won't really know how things have turned out until August, yet the stocks are acting as if a stellar performance is in the bag. I believe this is a case of putting the cart before the horse. Those holding on to housing stocks when the post summer earnings results are delivered may get burned. The following is my bear case regarding housing stocks.
Housing Market Backdrop
The US housing market boomed from 2001 until 2007 based on loose to non-existent mortgage requirements coupled with an investing public soured on the equities market due to the irrational exuberance created by internet stocks which generated a bubble inevitably leading to the "Dot Con" debacle. The boom peaked with the grand crescendo occurring in 2007 when the house of cards fell in a matter of months. For the past four years we have been digging our way out of the ruble and it seems this year we may have found a bottom. But the stocks of the top five new home builders have performed like we have a housing boom on our hands.
Too Far Too Fast
The U.S. stock market is off to a strong start in 2012. The Nasdaq (QQQ) is up approximately 17% year-to-date, the Dow (DIA) is flirting with 13,000, and the S&P 500 (SPY) is up 10%. Regarding new home builders, they are vastly outrperforming the major indices with KB Home (KBH) leading the way with an astounding 84% increase. PulteGroup, Inc. (PHM), Lennar Corp. (LEN) and DR Horton Inc. (DHI) are up 50%, 36% and 26% respectively with Toll Brothers Inc. (TOL) bringing up the rear at 21%. These rates of ascent are unsustainable and a near-term correction is both logical and healthy. After a run up of this magnitude, a period of consolidation would be normal.
Recent Housing Numbers May Be Misleading
It seems investors are interpreting the recent Commerce Department's report that U.S. housing starts rose more than expected in January with a 1.5 percent increase to an annual rate of 699,000 units as a huge positive for new home builders and began buying up new home builder stocks hand over fist. The issue with this is twofold. Firstly, the starts are largely attributable to multi-family rental property not single family homes. Secondly, many new home builders have inventory home fire sales in November and December to reduce their end of year tax liabilities.
While I worked for KB Home, we had a "November to Remember" sale every year and unloaded inventory homes as quickly as possible by offering deep discounts which cut into profits. I heard the sale on the radio last year as well. I believe the starts and sales data may have been misinterpreted by many investors unfamiliar with the situation.
Management Guidance Will Be Weak
Several recent high profile CEOs have used their earning calls to employ the tried and true stratagem of under promise and over deliver. John Chambers of Cisco Systems, Inc. (CSCO) and Meg Whitman of Hewlett-Packard (HPQ) just recently utilized this strategy when providing future guidance. I don't see the CEOs of the aforementioned new home building companies doing any different, nor should they. There are too many market variables to allow for significant visibility regarding future performance. This will most likely disappoint investors much the same as CSCO and HPQ did.
Major Headwinds Remain
There are major headwinds for the housing market that will keep it skidding along the bottom for some time in my view. First and foremost, people may be feeling better about things, nevertheless buying a home is a huge undertaking. I don't see buyers returning in droves until things are more certain regarding the disposition of global macroeconomic and geopolitical concerns. Secondly, many people had to make hard choices recently regarding paying their bills due to losing jobs or receiving reduced pay and have blemishes on their credit reports.
At the same time, mortgage requirements and regulations have made it nearly impossible to qualify. These two conditions make the cancellation rates go through the roof. It is easy to write a new home contract, the hard part is getting the home closed. Many builders hold on to the contract until all options are exhausted which can skew the numbers somewhat. Finally, rentals are up for a reason. People are concerned about being flexible in case they get a new job or have to move for their current job. You used to buy a home because it was a sure thing to increase in value, which is not the case any longer. People fear getting stuck underwater in a home now rather than fearing missing out on profitable sales transactions.
I am glad things are looking up for the U.S. housing market. I simply believe the new home builders have gotten ahead of themselves. All issues have not been properly resolved at this point nor the rebound proven. If I owned shares in these stocks and had a significant profit, I would at least sell half and play with the houses money going forward. If I was just now looking to get in, I would wait for a 5-10% pullback at least and layer in a quarter at a time over a month long period to reduce risk.
Additionally, set a stop loss order to minimize downside exposure. Corrections are healthy for markets and offer opportunities for short and long term investors. You can bet one is on the horizon for these white hot housing stocks. Use this information as a starting point for your own due diligence and research methods.