Drop In The Housing Market Index Ends Upward Momentum Of The Recovery, Delays Spring Sunshine

by: Duru

The latest Housing Market Index (NYSE:HMI) from the National Association of Home Builders (NAHB) and Wells Fargo demonstrates a very large and sudden drop in the confidence of home builders in January/February. The poor showing stands in stark contrast to the relatively bullish earnings reports from the likes of D.R. Horton (NYSE:DHI) and Meritage Homes (NYSE:MHI). The NAHB provided reasonable explanations for the 10-point drop to 46 but not for the size of the drop. Moreover, there could be a dichotomy in sentiment between the large, publicly traded builders and the rest of the industry if the latest earnings reports are still valid in their assessments.

The NAHB blamed "unusually severe weather conditions across much of the nation along with continued concerns over the cost and availability of labor and lots." The crush of the winter weather makes sense for explaining the drop in current confidence but not in the large drop in confidence in the West which includes large regions not impacted by severe snowstorms. Severe winter weather also does not explain why the index for future expectations also dropped so much. The concerns over cost, labor and lots can explain the rest of the drop, but it directly contradicts the persistent and consistent claims of home builders that 1) they have costs more or less under control and have the pricing power to keep pace, and 2) they learned their lessons from 2013′s selling season and came into 2014 with inventory ready to sell (like DHI). Moreover, major builders have multi-year inventory of lots to develop (MTH did mention it has struggled to get the quantity of lots it wants in California). So, I can only assume that most of the pessimism regarding costs, labor, and lots comes the smaller builders who keep getting squeezed by the larger, better capitalized builders.

The chart below shows the history for the three components to the HMI (for more background on how to interpret the relationships amongst these components, see "The Housing Market Index: Strong Trends, Correlated Components, and A Weak Northeast").

Click image for larger view…

The upward momentum ends for the recovery in the Housing Market Index

The upward momentum ends for the recovery in the Housing Market Index

Source for data: National Association of Home Builders

Note the large drop in the HMI breaks the strong uptrend that distinguished the current recovery. This break may indicate that the shock from this year's severe weather will put a dent in the overall economic recovery. To the extent the market reacts to such temporary factors, I think it will finally provide a buyable dip in home builder shares. Regardless, the poor HMI will almost certainly indicates a delay for the bullish tidings home builders delivered ahead of the spring selling season. Problems with cost and shortages in labor and lots are longer-term in nature. These problems continue to demonstrate that the legacy of the destruction of supply and capacity in the housing market supply chain lingers. The on-going inability to meet demand now will continue to generate pent-up demand for later (credit constraints are also generating pent-up demand).

The reaction in home builders was predictable but not severe. The iShares US Home Construction (BATS:ITB) dipped a fraction of a percent and at the time of writing is down another fraction of one percent. ITB remains marginally in breakout territory.

ITB clings on to its breakout move from consolidation in the second half of 2013

Source: FreeStockCharts.com

Be careful out there!

Disclosure: I am long DHI. 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.