The National Association of Realtors released its Pending Home Sales index for September last week (Sept 28). Pending home sales are based on an estimate of contracts signed on existing homes. The September report showed a 2.3% drop pending home sales from August to September on a seasonally adjusted annualized rate (SAAR) basis. The number originally reported for August was revised down. Wall Street analysts were expecting a 1% increase in pending home sales.
The Pending Home Sales index is considered to be a leading indicator for future home sales. While the report was unexpectedly negative, a detailed analysis of the data reveals an underlying negative trend that has developed in the housing market that is not evident from the headline report. The report reinforces my conclusion in my article on September new home sales that the housing market "bear" may be reawakening.
Although the Pending Home Sales Index recorded a year over year gain of 3% on a SAAR basis, the month to month drop of 2.3% (SAAR) was the third time in the last four months that the monthly comparison declined:
From June to July the gain was a barely negligible .4%. The SAAR adjustment theoretically "cleanses" seasonality from the numbers. Thus a downtrend in existing home contract signings in 3 out of 4 months suggests the possibility of renewed downtrend in homebuyer demand.
Notwithstanding the problems with the seasonal adjustments calculus, analyzing the not seasonally adjusted data yields a similar conclusion. As you can see from the data in the table above from the NAR's press release, contract signings dropped 16.5% from August to September. This contrasts with a 9% drop from August to September in 2014. The large drop from August to September 2015 relative to 2014 on a not seasonally adjusted monthly basis represents the probability, in my view, that fundamental market influences other than seasonal factors are in play. I believe it reflects the degree to which the demand for homes is declining.
Although the average price of an existing home was $10k higher in September 2015 ($255,000) vs. September 2014 ($265,000), the average 30-yr fixed mortgage rate was 3.79% in Sept 2015 vs. 4.20% Sept 2014. Using those average price points from the NAR September existing home sales report, the monthly cost of financing a home purchase, on average, declined slightly. In other words, the unexpected decline in new contracts in September is not attributable to the rising price of a home, as the monthly mortgage payment, on average, declined year over due to lower mortgage rates.
A major reason the housing market "recovery" since 2010 has been shallow is the first-time buyer cohort has averaged 30% of sales vs. a long term historically average of 40-50% of existing home sales.
(click to enlarge)
NAR chief economist Lawrence Yun makes the assertion in the pending home sales report that a lack of listings at the lower end of the market is the reason first-time buyer participation is still historically low. However, he does not point to any evidence that lower-end listings are low relative to the overall universe of listings. In fact, I presented a counter-argument in an article in which I detailed why the inventory of home listings is likely higher than the NAR data reflects.
Furthermore, the availability of mortgage financing increased considerably at the beginning of 2015, as Fannie Mae and Freddie lowered their minimum down payment required from 5% to 3% and the FHA significantly reduced its PMI premiums (PMI mortgage insurance is typically required on mortgages on which the down payment is less than 20%). Both of these factors significantly lowered the cost of buying and financing a home purchase and should have stimulated first time buyer demand.
I would suggest that the primary factor behind the historically low level of first-time buyer homebuying is seeded in fundamentals of the job market. The labor force participation rate for the first-time buyer age "bucket" is at a 15-yr low:
As reflected in the graph above, the historically low percentage of home buyers which are first-time buyers is likely a function of this demographics declining participation in the labor force. This is a fundamental economic problem that can not be addressed with Government and Federal Reserve intervention in the mortgage market.
If first time buyers are not buying homes, it affects the entire housing market negatively because the "move-up" buyer typically needs a first-time buyer as an outlet in order to sell and finance the move up purchase. As you can see in the graphic above, the labor force participation rate for the demographic that includes the first-time buyer began declining to a new low at the beginning of 2015. I believe this the biggest factor at work in the decline in pending homes sales for three out of the last four months.
If I'm right with my thesis, and you can withstand the risk of shorting anything in this market, the homebuilders represent a great opportunity to make money on the downside, especially if the Fed follows through with its threats and begins to raise interest rates in December. The easiest way to short the housing market is by shorting, or buying puts on, the SPDR S&P Homebuilders ETF (NYSEARCA:XHB). However, I believe that shorting individual homebuilders offers an opportunity to capture short-side alpha. My favorite short-sell candidates are KB Home (NYSE:KBH), Beazer (NYSE:BZH), DR Horton (NYSE:DHI), Toll Brothers (NYSE:TOL) and Pulte (NYSE:PHM). I have several homebuilder reports available on my website, Investment Research Dynamics. Because this is a treacherous market in which to short anything, prudent capital management is always advised.
Disclosure: I am/we are short KBH, BZH, 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.