Signs The Housing Market Is Starting To Head South

Includes: DHI, XHB
by: Dave Kranzler

Based on recent data coming from the National Association of Homebuilders (NAHB - new homes) and the National Association of Realtors (NAR - existing homes), my thesis that the housing market recovery is faltering is starting to bear some fruit.

I received an email last week from a reader relating a story about a friend of his who is a mortgage office trainer for Wells Fargo, which is the largest home mortgage bank in the country. He said she had an extremely busy schedule from August 2012, until about six weeks ago. Since then, they have not opened or upgraded one single mortgage office. Loan application volume has "fallen off a cliff."

Fundamentals matter. And this housing market "recovery" has not been based on true economic fundamentals. Currently the economy looks to be turning lower, in some cases quite rapidly. I've reviewed just some of the evidential data in this article: Economy May Be In Big Trouble. If the economy is not generating jobs and income, how can it possibly generate home sales - new or existing?

This morning the NAR reported existing home sales for the month of March. Sales missed estimates and were down .6% from February. February sales were revised lower - i.e. fewer existing homes actually sold than had been originally reported. The March number reported today was down 1.2% from what was originally reported for February.

The internal numbers were particularly bearish. First time buyers - the bread-and-butter buyer for the housing market - accounted for 30% of the sales. This is down from 33% a year ago in March. Co-op/Condo sales dropped 3.2% from March 2012. Please note that this is just in time for the coming increase in apartments that are now under construction as reported last week by the NAHB.

The most troubling part of today's report is the drop in all-cash sales, which dropped to 30% of sales from 32% last month. This segment of buyer is primarily the "investment" buyer. It's the segment where all the action over the last two years in the housing market has been. Big investment funds from New York City, and Los Angeles, (Blackstone and Colony Capital, for instance) have bought hundreds of thousands of homes from Fannie Mae, Freddie Mac and from distressed regions of the country, thereby building huge portfolios of homes intended to be converted into rentals (again, just in time for new rental supply from developers).

If there's been a true drain on housing inventory for sale, it's the all-cash investor segment that has been the primary cause. If this segment of buyer disappears, the inventory of distressed and foreclosed homes will quickly replenish, offsetting any true home price house gains that have been observed over the past 12 months. In fact, it was reported just a week ago that foreclosure activity in Nevada, one of the hottest housing markets over the past year, has ramped up significantly: Nevada Returns To Foreclosure Top Spot.

Moreover, if the economy can't support and create buyers for homes outside of the investor segment, how can the level of home sales over the past 12-18 months possibly be maintained? If anything, if the investor segment disappears, it will pull the rug on at least one-third of the housing market demand over those same 12-18 months. In support of my view on this matter, the NAHB reported last week that its builder confidence index declined for the third straight month, missing forecast expectations: Home builder sentiment falls again. Please note that this drop in confidence coincides with what should be the strongest period seasonally for the housing market.

If my view is correct or you agree with my view, how can we make money from seeing something that the overall market either does not see or refuses to accept and therefore is overvaluing these stocks? My first choice is to short any of the homebuilders that still have stock prices in double digits. I did a write-up on D.R. Horton (NYSE:DHI) at the end of January recommending a short on DHI when the stock price closed at $23.89: DHI's shrinking pile of cash. It closed Friday at $21.98, for a gain-to-date of 8%. I believe there are more gains to be had by shorting DHI. I also recommend puts on XHB, the S&P homebuilders EFT. Currently trading at $28.91, I like the June near-money puts, because I don't think it will take too much time for my housing market view to be priced into the stock market.

Disclosure: I am short DHI, XHB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.