Existing Home Sales For October Drop - Short This Bounce In Homebuilders

Includes: DHI, KBH, SRS
by: Dave Kranzler

Existing home sales for October were released this morning by the National Association of Realtors (NAR). My view as reflected in my articles posted on this site is that the bounce - being termed a "recovery" by industry and Wall Street - has been nothing more than a counter-trend move fueled by a massive amount of Fed/Government stimulus in the context of a nasty bear market in housing that started in mid-2005 (here's a link to my seminal analysis). The data on existing home sales further confirms for me that my thesis is correct. As such, I strongly recommend using today's "reflexive" bounce in the homebuilder stocks to exit long positions and to establish, or add to, short positions.

Although the headlines are reporting a year over year gain of 6% (seasonally adjusted), the month to month number from September to October dropped 3.2%. Please note, as my analysis is based on a month to month trend premise, the NAR numbers presented are seasonally adjusted. I have had questions on this in the past. The purpose of the seasonal adjustment process is to "cleanse" the data of seasonal bias in the numbers. This is done so that month to month comparisons can be assessed on an "apples to apples" basis - from the NAR website:

It is necessary to "annualize" and seasonally-adjust the existing home sales data so that month-to-month and quarter-to-quarter comparisons can be observed without seasonal variances distorting the overall picture

This is significant because it means that a 3.2% decline in existing home sales from September to October is theoretically "cleansed" of seasonal bias and that the actual demand for existing homes declined, ceteris paribus. This would reflect and reinforce my view that the "bounce" in housing is over and the housing bear market trend has reasserted itself.

You can see my point in this graph I sourced from Bloomberg:

(Click to enlarge)

As you can see from the red lines I added to the graph, this is the first year since QE and government stimulus policies were implemented in 2009 that the housing market has entered into a month to month decline starting in the middle of the summer. In fact, what makes the decline in home sales even more interesting and bearish is the fact that mortgage rates have been declining since the middle of the summer (dark red line). From September to October the rate for a fixed-rate 30yr mortgage dropped from 4.46% to 4.19 per the NAR data. And pricing was flat from September to October. These two facts would imply that "affordability" did not play a factor in the sales decline.

Furthermore, if you look at some of the individual data components provided by the NAR (pdf link), it reflects a systematic weakness in housing. Single family home sales declined 4.1%. In addition, sales were down in every region (North, South, Midwest, West), with sales down 7.1% in the West. This is the first time in recent memory that sales have declined in all four regions. Worse, sales literally plunged in the West region, which is the area that has been the hottest in terms of volume and price gains. Finally, the median time on the market increased nearly 10% from September to October, going from 50 to 54 days. This too, in my view, reflects declining demand despite lower interest rates.

Finally, the NAR offers the argument (in the press release linked at the top) that low inventories are a big part the reason that existing home sales are slowing down. However, I believe that this argument does not hold water when you consider two salient facts about bank REO (bank owned homes). First, you'll find in my "seminal article" link above an article which has data from Corelogic showing that banks are withholding from the market a very high percentage (as much as 90%) of their foreclosed inventory: Shadow REO. This more recent article with data from RealtyTrac estimates that 47% of foreclosed homes are still occupied by former owners and renters, with that number as high as 60% in Miami and Los Angeles: Banks are withholding REO. In other words, while the NAR data may rely on a seasonally adjusted estimate of listed homes on the market for its source of data, there is a very large reservoir of "shadow inventory" homes which should be considered when assessing the macro supply/demand characteristics of the housing market. This means that the potential real supply of homes is much greater than is being reported on a seasonally adjusted basis by the NAR. I cover this topic extensively in my article linked at the top. One more point about the NAR inventory data. To the extent that a relatively high number of homes may have come onto the market in the last couple of months, the seasonal adjustment calculation would actually under-estimate the true listed supply. I say this because I know from using Trulia.com and RealtyTrac that the number of listed homes in Denver has increased by quite bit over the last couple of months.

As I've laid out above with a close analysis of the existing home sales data released by the NAR, it appears to me that the housing market is re-entering its vicious bear market trend that started in mid-2005 and that systemic demand for homes is declining. On this basis, I strongly recommend using the bounce in the homebuilder stocks today to sell long positions. I would argue that money managers at the very least have a fiduciary to duty to their investors to reduce positions in the builders if they are overweighted or even market-weighted in the builders.

More aggressive traders can use this bounce to add to or establish short positions in either the Proshares Ultra-Short Real Estate ETF (NYSEARCA:SRS) or in individual homebuilder stocks. I am currently short DR Horton (NYSE:DHI) and KB Homes (NYSE:KBH). You can take a look at my previous articles on Seeking Alpha which discuss DHI and KBH. I am going to take a look at adding a few others to my shorts over the next couple of months, especially if the overall strength in the stock market helps the homebuilder stocks trade at this current level or higher. The one caveat to shorting the homebuilder stocks is that they are highly volatile due to the high degree of short-interest and because of the possibility that Fed could unleash even more QE into the system in the future. For this reason I always recommend that short-sale traders leave "room" to add to positions if the market moves against the trade for awhile. In the longer run, the fundamentals will reassert and I believe the fundamentals are pointing to much lower stock price levels down the road.

Disclosure: I am short DHI, KBH. 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.