Shorting the Homebuilders as Their Stocks Surge

There's an article in Fortune about the surge in homebuilders' stocks. Bill Miller may be right with his 1991 analogy -- but our money is on the 2001 analogy instead (we've recently shorted the ITB -- the iShares Dow Jones US Home Construction ETF). That year, the previous biggest bubble in history (tech/internet) was in the midst of bursting and the Nasdaq had fallen from 5,028 to half that. Many investors were piling in, thinking that after a 50% decline, tech stocks had bottomed -- but they hadn't, falling an additional 50+%.

Enormous bubbles don't burst cleanly, with prices returning to trend line. A study by GMO showed that in every bubble in history, going back to tulib bulbs, the bottom was reached far below trend line.

Given that home prices are still way above trend line and that, we're only seeing the tip of the foreclosure tidal wave today. It's hard to see how we're near a bottom in terms of the fundamentals or the stocks (barring a huge government bailout). Excerpt from the Fortune article:

The homebuilders ETF is up 29% off its early January lows, while components Toll Brothers (TOL), Lennar (LEN, Fortune 500) and Hovnanian (HOV) are up 40%, 52% and 96%.

So after two and a half years of steep drops, have the homebuilding stocks finally seen a bottom? Some investors believe they may have - and that the recent bounce foretells sunnier days for an economy that has been besieged in recent months by recession talk.

"What took us into this malaise will be what takes us out," Bill Miller, portfolio manager for the Legg Mason Value Trust, wrote this week in a letter to the fund's shareholders. "Housing stocks peaked in the summer of 2005 and were the first group to start down. Now housing stocks are one of the few areas in the market that are up for the year."

Miller, whose fund lagged behind the S&P 500 by some 20 percentage points over the past two years after a 15-year run of beating the index, sees a possible replay of the early 1990s recession. Back then, a brief, mild contraction followed a housing boom and a banking industry crisis - the failure of the savings and loans. Many stocks tied to the financial sector fell to deeply depressed levels in that episode, and investors who bought those stocks near their lows raked in huge gains when the economy recovered.

Housing stocks "were among the best performing groups in 1991," Miller wrote, "and could repeat that this year."

Comments

[tomyris:]

I do not see how you can compare the HB stocks which are still 70 % down over 18 months with the tech bubble of 2000. At that time certain stocks were being valued based on "eyeballs" or web sight viewings . I see no such situation in the housing stocks and do not agree that a major bubble was created in the house prices . If you are looking for housing bubbles look at Spain , Irelan and UK where house prices rose by 200 % plus over the past decade and scaremongers on the US housing stocks are pointing to 10 to 15 % above trend in the US. The fact is that the median US house price is only 240,000 $ which make them about the CHEAPEST in the developed world .
In fact I believe that were it not for the invention of CDO's there would be no US housing crisis .

I am with Bill Miller on this one. Houses builders are not comparable to Y2K Fantasies .

2008 Feb 24 07:22 AM

[Jack Swanson:]

Tomyris....after reading your comment above, I came to the quick conclusion that you are an idiot.

2008 Feb 24 08:42 AM

[islandcreek:]

As a financial advisor for more than 27 years, I also lived through the S&L crisis. I agree with tomris and bill miller. If you look carefully at the chart of Pulte, for instance, it had a rally of better than 25% from june, 2006 through feb 2007. I believe that was the rally before the futher decline that you think you see now. Nine months from now the present crisis will be history. Don't fight the last war.

2008 Feb 24 08:53 AM

[number2son:]

Bill Miller, tomyris and islandcreek provide amble evidence that the bear market for housing stocks still has a long way to go.

Miller made a colossal error in 2005 in buying home builder stocks at their top. Now he claims to be buying the bottom. He is either afflicted with fatal arrogance or stupidity. It makes no difference to me either way, but what does matter is that he is as wrong now as he was in 2005. In that, he has been consistent.

2008 Feb 24 09:27 AM

[Joe Friday:]

there is absolutely no evidence to show that the housing market is starting to improve. The factual evidence from the marketplace indicates that the market is still declining, and the inventory numbers would suggest that it will decline for the foreseeable future. Buying or shorting based on historical patterns that someone believes will repeat is pure folly. The market is dynamic place, no patterns repeat precisely.
Those homebuilders that survive will be great buys one day, but there is no reason to buy them yet.

2008 Feb 24 10:18 AM

[User 121302:]

The housing industry will continue to bleed. Stock is valued as junk. Buyer supply has been choked off. Governments still extort money from developers, for example, public art here, a fire truck there, and some set aside land for the snaggly-nosed pussygagle bird.

You will see more and more builders go bankrupt. Builders are losing hundreds of millions of dollars, collectively, in the billions. Also, with the anti-illegal immigrant trend, the builders are going to have to pay more for labor because they won't be able to safely use illegal immigrant labor.

Buying builder stocks now is like buying a rutting pig only to find out it's impotent.

2008 Feb 24 11:09 AM

[rpccpa:]

I love shorts when thebandwagon wants the downside. Bottom line... the BANKS ALWAYS win... AMBAC Bailout MBIA Next Citigroup US GOVT bailouts through FNM FRE.

Bottom Line = THE BOTTOM IS IN... LOCK N LOAD THE XHB - Bargain of Decade.

2008 Feb 24 11:19 AM

[t-bird:]

The analyst quoted did well with his fund while the market was rising. Look how he is doing now. Negative numbers.

Unlike 90-91 we are in a liquidity and solvency crisis. Individuals in 90-91 were not loaded with debt that they cannot adequately service. I see much further decline in the homebuilders and will add to my positions with HOV, LEN and BZH. I predict BZH will be in Ch. 11 by Summer or early Fall.

2008 Feb 24 11:24 AM

[t-bird:]

Island Creek; if you have been a financial advisor for 27 years I only thank the Holy Father that you do not manage my portfolio. I have been investing for over 30 years and manage my own.

I hope you remember your comment that this crisis will be over with this time next year.

2008 Feb 24 11:31 AM

[Greg Pinelli:]

The point of this articles is??? Shorting homebuilders...do you mean shorting the actual builders equities or finding an ETF that does that?

2008 Feb 24 11:37 AM

[Phil G.:]

He says his fund shorted the ITB - that's an ETF.

2008 Feb 24 11:45 AM

[Doug Poretz:]

I was a senior exec in a large public homebuilder in the mid 1980s through 1990. Do not dismiss that period -- if you were in homebuilding, you were in a depression. If you bought a house at the peak of the market, it probably took you 7 years or so to get back to your initial price. The depression was helped along by FIRREA (if i have the acronym right after all these tears), which was an unthinking over-reaction to the S&L crisis by Congress (surprise surprise). I remember how the market fell, basically in three stages -- an initial decline followed by a flattening, followed by a steep decline and then a flat period again during which some people said "it can't go any further." And then it really crashed. When people start saying "it can't go any further," i think: "is zero far enough?" Personally, i think consumers are still in denial, we are far from the bottom, we still have to live through the real crash, and then home prices and activity will bounce along bottom for maybe 3-5 years or longer. Stocks will recover before the actual residential real estate market recovers, but not this soon in the cycle. Wait until the housing market hits real bottom sometime in the next year or two. The trend in home prices and energy is south -- is there any reason to believe the trend will reverse? I don't see it ... nor do i see a flattening out. Things will get worse. As things get worse, more homeowners will be affected. Banks are just now starting to freeze home equity lines so that consumers cannot draw on what they thought they had available -- there is a very bad time yet to come. Very bad. Worse than we have seen in decades. Homebuilding stocks are enjoying a false rally. If you don't short them, at least don't own them.

2008 Feb 24 01:45 PM

[tomyris:]

Let me back up Jack Simpson's opinion with some more facts which I just pulled from Google :

Average house price in UK is 222 K £ equivalent to 432 k $
Average house in Spain is 246k €uros equivalent to 364 k $
Average house price in Ireland Dunlin area 397 K € = 587 k $
Average house price in Ireland outside Dublin 266€ = 393 k $

The median house price ( admittedly not the same as average but close ) in the USA is 240 K $ and believe me USA houses are a whole lot bigger .

If the USA has a bubble some European countries have hot air baloons . You got any facts Jack or are you blowing baloons ?

2008 Feb 24 02:24 PM

[BlackBart:]

I work in the homebuilding space and deal with almost all of the top 100 builders. The undeniable issues are as follows:

1.) An overwhelming amount of inventory. Take for instance the case of Naples, Florida with a year round population of approx 21,000. There are currently about 20,000 houses, condo's, etc. (resale only!) on the market.

2.) An inability for lots of builders to translate land sales into cash flow. Too many builders are reinvesting in land when they should be paying down debt.

3.) Over-valued inventory. Does anyone really know who is going to buy a $400,000 home in Stockton, CA with unemployment over 10% and average income clocking in at around $35k per year!?!

4.) De-centralized management. Most builder divisions operate as independantly owned micro-kingdoms. The efficiencies of scale that could assist in lowering material costs, increasing operating efficiencies and reducing staff are simply ignored for the sake of division presidents who are over-sized prima donnas in most situations. Their is no business in which C-level execs have less power than in the big building business.

Until a few of the big guys go out of business there will be no turnaround. Finally it is really the bankers who are to blame at the end of the day. They continue to extend the outrageous covenants rather than watching one of these builders go out of business.

2008 Feb 24 03:07 PM

[Barry Robbins:]

I am currently shorting Lennar (LEN). There is no evidence of a turnaround in the homebuilders. There is a vast oversupply of homes, a massive reduction in available credit, and foreclosures are rising. There is no way that a turnaround is coming for the homebuilders. When I see a few of them declaring bankruptcy, then I may take a closer look at the survivors. Eventually, Toll Brothers may be a buy - but not until 2009 at the earliest.

2008 Feb 24 03:50 PM

[john1:]

The fantasy about the affordability of US housing is based on the fantasy of the existence of the US middle class. Your country is now like any other 2nd world country (although you guys have lots more bombs) with a small upper class and a huge peasant class. The people commenting on sites like this are all in the upper class; and either don't realize it or can't admit it, but base their opinions on what members of their own class are thinking, which is completely understandable as who wants to talk with the peasants (certainly not me).

If the losers at the bottom can’t afford housing it doesn’t matter what the prices are in Ireland or the South Pole. It’s all about what the average dumb-ass can purchase in YOUR country. Your dumb-asses are flat broke, just like your country. Good luck in the next 5+ years.

2008 Feb 24 04:01 PM

[islandcreek:]

User 133274, I will remember my comments at this time next year. You sound like all the people who come to me, and ask me to give them numbers on how well I've done for my clients. But when I ask them the same question, they can't tell me how they've done on their own. It is easy to tell the difference between the pros and the amateurs on this forum. I'll take Bill Miller's opinion over yours every day.

2008 Feb 24 04:58 PM

[t-bird:]

Island Creek, I manage a seven figure family trust. Been investing for over 30 years and handle my own financial decisions. I have grown this trust over the last five years with an average compounded return of 18-20%. It is individuals like you with their Pollyanna attitude who are financial planners and are only interested in their fees and commissions.
The problem with the credit markets is not credit related. It is one of liquidity and solvency.
Remember what I said in my earlier post this time next year.

2008 Feb 24 05:25 PM

[islandcreek:]

133274, I lived through the Hunt Silver Crisis in 1980, The crash of '87, the S&L crisis and the high tech bubble. In my humble opinion, this time is not different, because it is never different this time. As rpccpa, pointed out, the banks always win. Why, because regardless of what you think of bankers, they are the underpinning of our economy. It may take a while but life will go on. Meanwhile, congratulations on your returns. Like Bill Miller the last couple of years, your're probably about to revert back to the mean like everyone does eventually. Enjoy.

2008 Feb 24 06:13 PM

[OracleLurker:]

Miller is right that the builders have undegone epic declines in the past only to launch, at the height of dispair, into new bull markets without ever looking back or even making a double bottom. The biggest difference between this period and the early 90's however is that, in the early 90's stock p/e multiples had bottomed out a decade prior and were in the process of trending higher, at roughly the midpoint of the secular bull market which ended in 2000.

Since multiples have been steadily declining from their 2000 peak during both the bear market from 2001-2003 and the bull market which ended in 2007 it is likely this process of mutiple compression is going to continue on for a number of years creating a significant head wind for most sectors - or to put it bluntly: we are in secular bear market. Unfortunately - they do happen.

2008 Feb 24 06:13 PM

[Kunst:]

Jack Swanson: "Tomyris....after reading your comment above, I came to the quick conclusion that you are an idiot."

There is no call for this kind of personal attack on this board. None of us know the future, we just have opinions.

2008 Feb 24 07:17 PM

[It be diffrent:]

Islandcreek I hope to goodness u're right. I know nothing of home builders and liquidity shortage, but I know (being from the oil patch) we are out of easy to find oil. And I know we can't build nuclear plants and or
go to mostly coal in a hurry. I don't think we can continue with our tremendous foreign trade deficit, etc , etc. Fuel from corn is a laugh and the bottom line is we must now compete for energy and many countries are ahead of us. Falling dollar,strapped consumers, no cheap gas for our suv, scary isn't it, could be a perfect storm. If so, look out below.

2008 Feb 24 07:31 PM

[Happydaze:]

One crucial thing that nobody really mentions here is that first time buyers -- the bulk of the public builders' customers -- cannot afford to buy homes at current prices by traditional measures.

The last 6 years or so was an abberation in mortgage lending, not the norm. Literally free money was given away to anyone who asked for it, regardless of ability to pay it back. Down payments were not required, loans in excess of the inflated values of the houses were granted, and multiple home purchase was encouraged.

As we've found out the hard way, this did not work.

Now we find out as mortgage lenders clamp down hard and require down payments, proof of income, financial statements, etc., buyers who can actually meet these requirements cannot afford the prices housing is going for. People who may have pretended to afford $400,000 houses a few years ago can really only afford $200,000 if they can come up with the down payment and other costs.

And now that the feed back loop is negative, why would anyone want to buy a new home now since prices are falling, falling, falling.

There will be no "V" bottom to this, but a miserably slow absorption of all the folly and fraud, as houses once again become somewhere to live, not somewhere to "invest".

2008 Feb 24 07:32 PM

[Happydaze:]

One other stock specific point.

The so called rally in the builders was not isolated to that sector.

In case you've forgotten, this rally occured after Bernanke did the emergency 75 BPS cut followed by another 50 BPS which triggered a tremendous short squeeze in many stocks, not just the builders.

Nothing fundamental about the builders has changed for the better, and in fact continues to worsen.

So anyone thinking the now breaking-down rally in the builders signals a bottom in this sector is fooling themselves.

And quite naturally, the proponents of the Real Estate Industrial Complex will continue to call a bottom to the housing market with each new month, just as they have done since the decline began two years ago.

2008 Feb 24 07:46 PM

[JREB777:]

Pricing this is simple. Go back to before the beginning of the housing bubble 1999 and look at the price of the HBs. We will be there before we go any higher.
If things really get uggly, I don't believe they will, then we may go back to 1992-94 stock prices. Back then they where worth 1/20th what they are worth today.
Good luck, but the trend is lower.

2008 Feb 24 09:06 PM

[Bubblesee:]

Bill Miller tried to play this housing downturn like the 1989-91 downturn and he simply got it wrong.

If he is long the wrong homebuilder he WILL end up watching it go to ZERO because thats where at least a few of them are going!

I covered half my short positions on TOL and MTH in Jan. and i used the money to short CTX a couple weeks ago at 27.

If the market gets a pump from this Ambac bailout nonsense i will definitely be taking more short positions either in Homebuilders of some of the other sectors of the market (like retail or commercial RE) that are about to fall.

This is NOT 1989 and because it is an entirely different animal (or shall we say credit crisis GORRILLA!!) we still have QUITE a ways to go and so do the builders.........

2008 Feb 24 10:20 PM

[TKP Investor:]

Managements have no visibility as to when the mkt will stabalize; mortgage lenders have done a 180; D. Tomintz DHI CEO in 3/07 fired a nice warning - "2007 is going to suck, all 12 months of the calendar year" - probably applies to 2008; the pure homebuilders are running their businesses for "liquidity" in order to preserve cash in hopes of surviving the current downturn; question - why does any homeuilder (DHI, LEN, CTX, PHM) still pay a dividend?; hedge funds will be buying land/developments at cents on the dollar which will help ease the builders liabilities/small liquidity boost (but with writeoffs); but believe many builders will see their equities wiped out and the next "owners" will be the professional distressed community who will be buying debt once it reaches 40 cents on the dollar (or less) -- they will then sell off the assets in pieces; Could also see foreign buyers (sovereign wealth) step in - ultimately - and take advantage of weak prices and weak US dollar, but they are more likely to buy distressed comm'l real estate (rather that homes/land) once that sector sees more pressure.

2008 Feb 24 10:33 PM

[Living Off ...:]

Bill Miller said"What took us into this malaise will be what takes us out".

Thats the stupidest thing I ever heard in a long time. It sounds suspiciously similar to Ben Bernanke's motto. If low interest rates caused the severe asset inflation and the bubble, then low interest rates will fix it!!!!!!

Regarding the reader who thought that US homes prices are cheaper than many parts of europe and therefore are not likely to decline further; that's wrong too.
Europe has much higher population density than the US. Easy liquidity is causing UK investors to speculate in the UK and in Spain. This has started to dry up and prices will fall there eventually as well.

Someone mentioned reversion to the mean. That's correct, home prices in the US will revert to the mean. This mean is about 3-4 times the average annual salary for an area. Right now its about 5 times in many places. It'll probably decline to the lower end end of the value spectrum before rebounding to fair value.

No offense to Islandcreek, but many of the financial planners are clueless. they're nothing but glorified insurance agents pushing annuities because of the high commission and tail. That being said, one of my close friends is a planner is very good and incredibly successful. I don't know you so I can't say which camp you fall into, but being an FP doesn't automatically assign you extra credibility, in my opinion.

2008 Feb 25 12:34 AM

[robert99:]

To the few longs here on homebuilders:

Take a look at the Shiller Used Home Price Index, adjusted for inflation, since 1890, and consider joining reality.

2008 Feb 25 05:17 AM

[islandcreek:]

LOD, You are right on both counts on FPs. Yes, like your friend there are many who are competent and successful. Unfortunately for me and him, there are far too many others who are glorified insurance agents. I do not blame the public for being negative on FPs. They need to do their homework to find a good one. The best and most respected credential is CFP.

2008 Feb 25 06:44 AM

[Ex15:26:]

It seems like there is a worst of all scenarios happening for homebuilders. No stats here, just thoughts. Homebuilders are still facing;
1) Inability to move current inventory
2) Declining housing prices and sales
3) Credit issues for their potential buyers. Jumbo loans are almost impossible to get in some areas.
4) Rising commodity prices - impacts pricing even more
5) Any thoughts on labor issues as Feds tighten up on illegal immigration given the Dept of HLS recent announcement?
6) Here's the positive, as a contrarian as soon as the entire market believes that all homebuilders are done for, it's time to begin researching (not necessarily buying). - there are regional pockets that have not been impacted. In Houston for example, inside the "loop" sales of $1MM + homes are the best ever recorded.

Does anyone know of some regional buiders that are showing strength?

Finally, I'm not buying the relative value arguement for housing in the US versus Europe. It is very clear that home prices in England for example have been a result of a bubble. That is like saying that NY real estate is so cheap compared to Hong Kong properties. Ask someone that bought in San Francisco three years ago if they think they got a good deal on their property, chances are they owe more on their mortgage than what they can sell it for relative value or not.

2008 Feb 25 10:42 AM

[tomyris:]

The reason I brought up the relative value argument is to counter the consensus that an "enormous bubble " had been created .

A bubble sure but not an enormous one , therefore had it not been for the creation of CDO`s and ensuing credit crunch due to banks holding the bag the slump would never have been as severe .

Thats why I believe that as the credit crunch is worked out the housing market can recover in short order.

I could be wrong , but if you dont try to buy low you will never sell high , and isn´t all investing an evaluation of upside versus down ? .

Does any one have data on foreclosures before for years before the loans were packaged into CDO´s , I suspect they got fairly high on occassions without causing a credit crunch or slump.

2008 Feb 25 01:53 PM

[jerry p:]

tommyris must have thought that pets.com was cheap at $80 because amazon stock was at $400

Could it be that the US is in less of a bubble than Europe? That doesn't mean that it isn't in a bubble. Prices in Spain are already starting to crash and the government there is talking about a bailout.

If the credit crunch is nearly over, then why are the banks trying to bail out the insurers? Why is the government talking about bailing out the banks? Who is willing to bail out the bankrupt government? Is there further demand for US T-bonds at 4% when inflation is at 4.5%?

Yes, the banks may win again, but how does that translate into this being the bottom for homebuilders?

2008 Feb 25 02:59 PM

[tomyris:]

The tax payer will bail out the goverment as always .

2008 Feb 25 04:16 PM

[FL TAXMAN:]

Since i started in 1970, i have never seen my clients in such financial trouble.
Dozens have and will be foreclosed on their homes.
Every day i see 10 clients and 2 to 3 clients are withdrawing from their Retirement plans to stay afloat.
In summary...the other shoe has yet to drop..the pending foreclosures will hit the banks in the first quarter. In my opinion...that should be near the bottom.
As a financial advisor, i have told dozens to save themselves financially and give the keys to the bank and rent a home instead.
Thank goodness the Stimulus package will save us.

2008 Feb 25 06:02 PM

[vodka_tonic:]

he shorted the ETF even after a 50% decline in value !!!! bad investment play.

2008 Feb 25 07:20 PM

[jbs:]

Everyone thinks they are right. Half of you will be. Congrats.

None of us knows where the market is going. I just like to get time on my side and average down with a safer index rather than individual stocks that might go to zero.

If I have a specific view and am confident in it then I will take a specific position in a company. But I don't see any level of analysis here that convinces me that anyone is much more likely to be right than a coin is likely to land on heads.

Isn't time better spent looking at the value of individual builders rather than guessing at which direction the market is going?

2008 Feb 25 09:43 PM

[Jeroen:]

Although the relative value (Europe/US) argument might have some merit at first sight (yes, real estate is expensive everywhere, and e.g. Spain/UK are in trouble), if you want to do a realtive bubble comparison you also have to take into account savings rates, tax law, quality of construction, job market, debt service ratios. And the resulting prices in dollar-terms, might say more about the relative value of the dollar, than the property market per se.

2008 Feb 26 08:05 AM

[tomyris:]

JST ,
I accept your point that European houses look expensive in devalued bucks , but even if you adjust by 25 % to take account of that, which would bring the Euro back close to its original value of 1 euro = 1.18$ , the US bubble is insignificant compared to the EU one .

2008 Feb 26 09:07 AM

[thehynie:]

Here we are in the middle of the housing depression, and DR Horton reports a positive cash flow of $550 million in the quarter, and reduced their inventories as well. They still have some gross margin left, but orders are way down, which could mean trouble for this quarter. Still, management is clearly responding to the conditions and figuring out how to survive. This is an anomaly--but ultimately the stocks will start trading on the cash flows. Still cautious due to the order slowdown this quarter, but looking for evidence of management's getting their houses in order. Looks to risky to short ITB from here. Demographics still a powerful indicator of future housing demand. If people want cheaper price points and smaller houses, the builders wil oblige--profitably.

2008 Feb 26 09:22 AM

[Jeroen:]

news.bbc.co.uk/1/hi/pr...

"Average annual earnings in Germany and Britain are similar: £20,981 (euro30,984) in Germany compared to £22,950 in the UK. "

"The average house price in Germany is £148,971 (euro220,000), whereas in Britain it is £196,893. "

2008 Feb 26 11:14 AM

[tomyris:]

This is where I got my data - I did not look for the highest just took the first that came up in Google . Agreed houses in Germany did not participate that creates an interesting dilema for the ECB who cannot lower interest rates to help Spain and Ireland out.
Ireland
finfacts.ie/irishfinan...
UK
news.bbc.co.uk/2/share...


: Kyero.com Spanish House Price Index - independent and accurate ...Although we've been recording the asking prices of property in Spain since mid 2005, I suspect that ... The national average property price is now €246000. ...
prices.kyero.com/ - 24k - Cached - Similar pages - Note this

2008 Feb 26 02:49 PM

[Opps Didn't...:]

Having read only half the posts I think we are missing a fundamental point. The developers appreciated in price because there was demand for a massive glut of new homes, in addition due to fancy financings we created a system that allowed developers to inflate prices, which is why their stocks did so well over the past years.

The biggest result of the past 7 years is that we've now produced an incredible amount of new homes on the market and no longer have a system inplace to create artificial demand. New and now old supply (created by foreclosures) will leave the market with ample demand.

Resulting in a dramatic decrease in business for home developers - you'll see industry consolidation and then in enough time when the country sees real GDP growth or loose credit another housing market boom will take place.

But for now, buying home builders is a pure momentum play.

2008 Feb 29 01:03 AM