Weak Housing Will Bring the Market Down

Includes: HD, KBH, PHM, USG, XHB
by: SA Eli Hoffmann

Excerpt from our One Page Barron's Summary (receive it weekly by email by signing up here):

The No-Money-Down Disaster by Lon Witter

Highlighted companies: SPDR Homebuilders ETF (NYSEARCA:XHB), USG Corporation (NYSE:USG), Home Depot (NYSE:HD), KB Home (NYSE:KBH), Pulte Homes Inc. (NYSE:PHM), Toll Brothers Inc. (NYSE:TOL)
Summary: New homes prices have dropped almost 3% since January, new home inventories are at near record levels, and existing-home inventories are 39% higher than last year. Sales have dropped more than 10%. Yet many stock market analysts have ignored the implications of these figures, betting that housing prices will continue to rise, supported by wage-increases, inflation, and GDP growth. They may be overlooking the fact that while inflation and wages have just recently begun their climb, housing prices have run-up since 2001, and are now at unsustainably high levels. Mean-revision dictates a 30% fall over the next three years. Furthermore, examining the four factors that brought-on the housing bubble; an influx of cash brought about through the collapse of the internet-stock bubble, rock-bottom interest rates, economic history that suggests housing prices never fall, and irresponsible financing of housing purchases, gives an indication of the impact the drop may have. Some salient numbers: 32.6% of new mortgages and home-equity loans in 2005 were interest-only, up from 0.6% in 2000. 43% of first-time home buyers in 2005 put no money down. 15.2% of 2005 buyers owe at least 10% more than their home is worth. 10% of all home-owners with mortgages have no equity in their homes. $2.7 trillion dollars in loans are slated to adjust to higher rates in 2006 and 2007. Banks have begun floating home-loans, leading to negative amortization (payments not covering interest charges and the shortfall being added to the principal). Since the end of 2003, the percenatge of loans in negative amortization has gone from 1% to 47%. Once it becomes clear to investors that the housing market has begun a significant decline, it will likely take the entire stock market with it, potentially leading to a 25%-30% decline.
Quick comment: The author notes that in a recent Barron's poll, not a single money manager ranked housing-market problems among the factors likely to lead to a stock market selloff in the next 12 months. Sometimes, the 'surprise factor' can lead to the most violent and unforeseen reactions. For an opposing view, see The Impending Housing Market 'Implosion' is Overblown, where the author makes the point that despite economists' threats of impending disaster, predictions of housing-market gyrations have historically been poor. As well, the numbers behind the headlines continue to 'surprise' the pessimistic pundits. The SPDR Homebuilders ETF can be used to play the sector, as can individual stocks such as Home Depot, USG Corporation, KB Home, Pulte Homes Inc., Toll Brothers Inc., and others.