December Pending Home Sale Index: Are Existing Home Sales In A Freefall?

Includes: DHI, PHM, RYL
by: Dave Kranzler

The National Association of Realtor released its Pending Home Sale Index - PHSI - for December on Thursday morning. I have been suggesting per my previous articles on the housing sector that a downtrend in the data behind the headline reports has been developing and that this downtrend is starting to accelerate. Today's Pending Home Sale Index report further confirms my view.

The report shows that pending contracts for existing homes in December dropped 8.7% from November to December (all data is from the link above unless otherwise noted). This was the largest month to month decline in the index since the homebuyer tax credit expired in 2010. Not only did the result miss the consensus expectation of -.5%, but it was significantly higher than the low-end estimate of -2.5%. Furthermore, November's number was revised lower. What was originally reported as a slight increase from October now shows a .3% decline.

The PHSI is an important leading indicator of home sales because it tracks the number of contracts signed in a specific month which can result in actual sales one or two months later. A big decline in contract signings implies lower actual home sales numbers will be reported in January and February. What could further exacerbate the reported decline in pending home sales is contract cancellations. This index shows contract signings. In between signings and closings, there will be cancellations. In my view, the successive string of downward revisions in existing home sales reports, which I have detailed in previous articles, is being caused by a higher than expected number of cancellations, which tends to occur when the market is declining.

The accelerating decline in sales is punctuated by looking at the actual data vs. seasonally adjusted annualize rate. Because of obvious seasonal factors, I like to look at year over year actual data for each month (included in the report linked above). If the market is growing, any month this year should show growth over the same month the previous year. This cleanses seasonality from the analysis. November 2013 actual signings declined 4.5% from November 2012. December 2013 actual signings dropped 6.1% from December 2012. Again, the increase in the decline of the month over month actuals add further evidence to my view that the decline in home sales being reported is accelerating.

One point about the cold weather in December. The chief economist of the NAR partially attributed the decline in contract signings to "unusually disruptive patterns of weather" (NAR press release) across the country. However, Goldman Sachs (sourced from Zerohedge) issued a report today which disputes the "bad weather" excuse. As you can see from the information in the link, the declines were broad-based regionally, with a couple regions experiencing normal temperatures throughout the month. To be sure, I'm sure the weather in some areas might have slowed down foot traffic on some days. But the weather wasn't below normal every day in December and it is likely that anyone who intended to look for a new home did so on a warmer day. Last time I checked, realtors are available for mid-week appointments in the evenings after work. I agree with Goldman that the weather is not a valid excuse.

On the basis of today's Pending Home Sales Index, I am more confident in my view that the housing market is in decline and that the decline is accelerating. Although this metric applies to the existing home market, there's a high correlation in new and existing home sales. I continue to believe that the homebuilders are extremely overvalued in the context of my forward outlook for home sales. One thing to keep in mind is that homebuilders use a high level of debt in their operations, which means in good times they have great earnings but in bad times they lose a lot money. I've noticed in scanning the latest quarterly reports that most homebuilders issued more debt last year and used the proceeds to increase their inventory of land and unfinished homes by a significant amount. If my view is right, 2014 will be a very bad year for homebuilder earnings.

One more point, the homebuilder index has run up quite bit over the last couple of weeks on earnings reports by DR Horton (NYSE:DHI) and Ryland (NYSE:RYL). But those numbers are "rear view" in nature and the homebuilder values reflect, in my view, expectations that are way too high for what I believe will unfold in 2014. I first recommended shorting the homebuilders when the Dow Jones Home Construction Index (DJUSHB) was at 515 about a year ago. It ran up to 550 over the next few months before reversing and going below 400 briefly. Now its back to 515. I believe it will reverse sometime in the next several weeks and go even lower than its September 5, 2013 close of 390. I plan to issue a report on DHI's and Pulte's (NYSE:PHM) earnings soon. As soon as Ryland releases a 10-Q with a statement of cash flows I will report on its earnings too, but I started a fresh short position today in RYL (with plenty of room to add to it if the market goes against in the short term).

Disclosure: I am short DHI, KBH, RYL. 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.