It's the House Prices, Stupid

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Includes: IYR, KBE, KME
by: Charles A. Smith

Bank stocks have noticeably underperformed the September stock market rally, and my sense is that expectations of meaningful (down another 10% over the next year or so) further declines in home prices may have something to do with it. Case-Shiller results released yesterday morning show the 20-city composite home price index declined 0.13% in July, this following a downwardly revised 0.24% increase in June. The numbers were in line with consensus estimates, and with the July print the index has risen 3.18% year over year, down from the 4.64% and 4.21% year over year gains recorded in May and June.

Lagged effects of the home-buyer tax credit, which propped up prices through the spring and early summer, have begun to dissipate. The real, unadulterated housing market should begin to show through over the next several months, and my guess is it won't be pretty. The large pipeline of delinquent mortgages combined with record numbers of vacant properties and the disappearance of the "move up" buyer will see to it. Recent year-over-year gains are likely to turn to losses by the time November results are reported next January, and the annualized rate of decline may again reach double digits next spring, as the index laps the stimulus-aided 2010 comparables.

No need for panic, as collectively the banks are in much better shape capital-wise than they were in the fall of 2008, but anyone expecting robust dividend increases to catalyze bank stock returns in 2011 might be sorely disappointed. Instead of paying it out to shareholders, bank managements will continue to husband capital to plug the holes left by the great housing collapse of 2007-2012. To add insult to injury, Federal Reserve efforts to further flatten the yield curve via QE2 could also hamper the bank profit engine. So it’s not just moribund capital markets weighing on the bank index; ongoing issues with regard to asset quality and earnings generation could also be hurting the shares.

Disclosure: No positions