Bloomberg recent reported that homebuilders are buying land after years of inventory cuts. Coupled with a buoyant new home sales report, some investors have concluded that housing has bottomed and is poised to rebound.


Wait for the relative breakout
The chart below shows the S&P 500 Homebuilders Index relative to the S&P 500. Relative to the S&P 500, the Homebuilding group is currently undergoing a basing process, but calls for an upturn may be premature. Technically, the group needs to break out of its relative trading before we can definitely call for a recovery.

As recently as 2006, the construction sector of the economy was as large as $1.2 trillion annually. While the decline in residential construction has had most of the headlines, non-residential building construction and heavy construction (mostly infrastructure related) has has been holding up much better. That appears to be about to end.

An online seminar July 23, sponsored by Georgia-Pacific (here), addressed the current state of the construction industries. The speakers were Jim Haughey, Chief Economist for Reed Construction Data (here), Ken Simonson, Chief Economist for the Association of General Contractors of America (here) and Kermit Baker, Chief Economist for the American Institute of Architects (here). The 70 slides presented are available on-line here. Some of the highlights are covered in this article.

Housing starts in June rose to the highest level in 7 months, after falling for 3 1/2 years to the lowest levels since records were first kept in 1959. Residential construction as a percent of GDP also fell to its lowest levels ever. After languishing for 9 months, the stocks of major home builders are now beginning to rise. It would appear that we have finally seen the bottom in the housing construction market.

Looking back to the beginning of the current recession, there were two things that initially put the brakes on the economy: 1.) the sub-prime melt-down and 2.) virtual halt of residential construction. They go hand-in-hand. As new homes are constructed, many were being bought by those wanting to upgrade. In turn they had to sell their house. Eventually, as new home construction expanded while the buying population shrank, the only way to feed the beast was to expand the sub-prime market. Like most houses of cards, ultimately it failed.

Has housing finally hit bottom?

Some of the biggest potential overshooting in home prices on the way down is in states such as Arizona and Florida, areas where major overbuilding took place during the boom. "Where this glut is occurring is fortunately in places where people still want to go," Case said.

While the heavy bearish sentiment should translate to limited downside, the potential for upside is similarly slim; resistance from the security's 20-week moving average looms just overhead in the 16 region. In short, it looks like KB Home should hold steady on the charts after earnings, since expectations on the Street are so unanimously low. Barring any major positive developments, look for any post-report moves to be muted.

There is no sign of a let up in the housing slump, and now there are indications that homebuilders like Toll and Hovnanian Enterprises (HOV), which have significant investments in the NY area market, will be facing greater headwinds there this year. The NY real estate market has held up relatively well since the housing slump began.

The builder plans to take advantage of dislocation in the land market by creating a separate entity with separate funds to buy land on the cheap. This way the company can focus on homebuilding alone. However, analysts fear that this is a redux of the separate LNR entity that Lennar created in the 90s and which caused the company a great deal of grief until they finally spun it off.

As hedge funds fail however, the pool of potential partners is contracting. Surviving hedge funds will likely be wary of joint ventures. Cautionary tales such as Calpers' could be a big inhibitor. Fewer partners to take advantage of land deals when banks unload them could prolong an already long-way-off recovery.

The government is doing its part by forcing lower mortgage rates. The question is whether the market should run its course and regain equilibrium naturally (and at great pain to the American citizen) or will artificially lower mortgage rates make the bottom happen and stick.

For those thinking homebuilders will someday soon be reporting high revenues and margins:

Apparently not all segments of the housing industry are doing badly. Home Depot (HD) jettisoned its building supply company early on in the housing slump, and USG (USG) has reported poor numbers this quarter.

Beacon Roofing Supply's (BECN) quarterly results bear the Home Depot trend out, but what about USG? Beacon says complimentary building products like nicer doors and decks are not faring well, but people will always need a roof over their heads. From Beacon Roofing Supply’s FQ408 conference call:

Inventory-related and goodwill impairment charges of $95.5 million and $4.4 million respectively contributed to a net loss per share from continuing operations of $2.85 compared to a loss of $3.09 in the prior year.

Hat tip to BoomBustBlog member Christopher Alleva for contributing this interest comment on my Homebuilder Bailout post.

From 2002 to 2006 these Builders reported taxable income of $52 billion, based on a 39.3% tax rate, these builders have paid more than $20 billion in taxes during this period. So far these builders are reporting $10.6 billion in pretax losses for 2007. Under current law, they can only claim refunds for taxes paid in 2005 and 2006, $10.7 billion at the 39.3% rate, which means collectively they've run out of carryback losses for future years, including 2008. Each builder's tax position is unique but to the extent they claim refunds they may consider writing down or selling assets to realize the losses. The nation''s largest builder, Lennar has been most aggressive on this front claiming more than $3 billion in losses for 2007 allowing them to claim most of $1.2 billion in taxes they paid in 2005 and 2006.

2007 was a banner year for ETFs, with assets rising $215 billion (or 51%) over year-ago levels. Let’s look at where each company stands at year-end.

Based on data from the Amex, the U.S. ETF industry ended the year with total net assets of $632 billion (as of 12/28). If you add in ETN assets, that number jumps to $637 billion. That’s up nearly $215 billion from the ICI’s 2006 estimate of $422.5 billion. Not bad ...

A new exchange-traded fund [ETF] company debuted on Friday, as FocusShares LLC listed four new ETFs on the NYSE Arca platform. The new funds are all tied to indexes from the options-focused International Securities Exchange (ISE), and represent one way that exchange is looking to capitalize on its indexing research efforts.

The new funds are: