Breaking Down the Case-Shiller Index

"Home prices down a staggering 16%!" and "Property values plummet!" are what the headlines read after the Case Shiller report was posted on Tuesday, July 29. Perhaps, it is the media's obsession with de-moralizing investors, or maybe it is our custom of judging all of our economic reports on a year over year basis, but we urge investors to take the headlines with a grain of salt (they are just trying to get your attention). Homebuilder stocks climbed 7% on average on Tuesday during trading following the report because, believe it or not, it was good news.

The May Case Shiller index, which measures average home prices taken from a sampling of 20 U.S. cities, was down 15.8% from last May, but was only down 0.9% from April. The last time the index saw such a small month to month decline was in September 2007. In today's housing market, falling prices are completely expected, and the fact that the decline decelerated in May is a slightly positive step towards a correction.

A key part of the report is that seven out of the twenty cities sampled showed month to month price increases. Denver, Atlanta, Boston, Minneapolis, Charlotte, Portland, and Dallas showed modest improvements. These results show a regional nature of our nation's housing crisis. It is the areas such as Las Vegas, Miami, and Los Angeles, which were, and continue to be, the hardest hit regions, that drag down the rest of the country and steal the headlines. Take Charlotte for instance, home prices in the growing North Carolina city are flat on a year over year basis and in Dallas, prices have risen more than 1% in each of the last three months. The movement in some of the healthier areas of the country suggests that the buying interest is returning, and prices are back on an uptrend. On the other hand, in areas such as Florida and California where prices became especially inflated during the housing boom, foreclosures continue to pile up and these regions may continue to experience worsening environments for months to come.

Clearly, the May Case-Schiller report is nothing to pop the champagne over, but it shows the market's capacity to change. The rate of month to month decline in home prices has decelerated in the last three months reported. It began with a 2.7% decline in February (the peak month-to-month drop in prices to date), slowing to declines of 2.1%, 1.3%, and 0.9% in March, April and May, respectively. Two regions showed month to month increases in March, growing to seven regions in May. With the rate of decline dropping lower by the month, if this trend continues, home prices will start to rise within the next few months. It would certainly be too optimistic to say that this is actually the beginning of a bottom, but it is sure starting to look like one.

We are going remain on the conservative side and project that we are not going to hit a bottom within 2008. Certain homebuilders with exposure to the better performing regions of the country have a chance to become more profitable as the year goes on, even if the fundamentals of the housing market continue to decline.

Pulte Homes Inc. (PHM) and Centex Corp. (CTX) are two companies that have already sold off large portions of inventory in problem regions, and are mitigating massive impairment charges that have been plaguing the homebuilders' balance sheets. In both cases, at the end of the fourth quarter of calendar 2007, these homebuilders wrote off as much inventory as possible (think kitchen sink) in a proactive manner to lessen the need for further write down in future quarters. This affords these homebuilders the opportunity to earn benefits from prior impairments. Having sold off large portions of less valuable land in problem regions such as California, these businesses may experience improving gross margins with a better regional mix of products. Both companies have strong footprints in areas such as Texas and parts of the Northeast where, as demonstrated above, prices are more favorable. Finally, cost cutting initiatives are materially reducing overhead expenses. We believe that the calendar fourth quarter was the worst it will get for the aforementioned homebuilders, and as such, will be shielded enough to weather the rest of the storm and possibly even improve profits until the eventual turnaround, at which point the stocks will appreciate nicely.

Click here for a copy of our latest comprehensive report on Pulte Homes.

Written by David Urani a Research Analyst for Wall Street Strategies (www.wstreet.com) specializing in the homebuilding, staffing, medical devices, and logistical services industries.

Disclosure: none

Comments

[bmd4golf:]

it would help is case shiller would segment the info by price range. the low end (foreclosures) dominate the data set which lowers the averages. not a true picture of all price ranges.

2008 Jul 31 12:47 PM

[Urbane Gori...:]

What bmd4golf states is true.. But, the lower end homes are where beginning homebuyers get their start, where our new additions to the workforce live and where those that are moving up are trying to sell out of. In effect, the impact on cheaper homes has a much more profound impact on society than say the recent disclosure that Johnny Carson's sidekick can't make his house payments.

As an aside, Financial Title Company just went belly up yesterday, and aside from Indymac, two other banks were seized by the Feds this week. Sounds like the right time to load up on banks and real estate to me.. (**Disclosure.. That was sarcasm!!!**)

jegan ;-)

2008 Jul 31 02:41 PM

[ArnoldCountry:]

Many of the sales taking place at the low end of the market are not new entrants to the market but speculators... we are not at a true market, even at the bottom. New homebuyers are not really entering yet.

2008 Jul 31 03:13 PM

[joker:]

This dude is ridiculous! You can a month-over-month decline of 0.9% "small"? Well, how about you have this "small" declines in your house and portfolios for 2 years? You will be a real "dude" if you still can the 0.9% decline "small" after you cumulate for 2 years.

2008 Jul 31 04:31 PM

[Manny Golds...:]

The lack of greater price decline could easily be due to seasonal price fluctuations. Housing prices are typically highest in late spring/early summer, and the Case Shiller index is a 3-month moving average. Thus, in a rapidly declining market, one would expect the least decline right around now.

2008 Aug 01 11:55 AM

[Jeffrey Ropp:]

I've also been studying this housing market metric and have put together a robust set of charting tools to depict this information. In addition to the simple aggregate indices (or year over year comparisons), users can also view an index for a market subset (e.g. higher price homes in Los Angeles). I think you'll find the difference between these market subsets yields an important perspective with the additional granularity. Also, the site picks up the latest futures prices from the Chicago Mercantile exchange providing a look ahead in the coming months and years. Let me know what you think!

2008 Aug 27 02:33 AM