The Homebuilder Stock Train Wreck

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Includes: CLAW, HOML, ITB, NAIL, PKB, XHB
by: Dave Kranzler

One of the proprietors of StockBoardAsset.com tweeted about two weeks ago wondering when the stock market was going to start pricing in a slowdown in the economy. To that I responded by pointing out that the DJ Home Construction index is starting to price in a housing market crash. Residential construction plus all economic activity connected to selling and financing existing homes is probably around 25-30% of the GDP when all facets of the housing market are taken into account (realtor activity, mortgage finance, furniture sales, etc.). It's quite surprising to me that almost no one besides the Short Seller's Journal has been pounding the table on shorting the homebuilders.

In the mid-2000s financial bubble, the housing market's demise preceded the start of the collapse of the stock market by roughly 18 months. This is what we are seeing now. Again, to rebut the tweet mentioned above, the homebuilder stocks and the housing market are strong leading indicators.

The chart above is the DJ Home Construction Index on a weekly basis going back to April 2005. The homebuilder stocks peaked in July 2005, well ahead of the 2008 financial system de facto collapse. Back then, the index plummeted 51% over 12 months before experiencing a dead-cat bounce. So far, it's dropped 33% from January 22nd. Regardless of the path down that the index follows this time, it still has a long way go before the excesses of the current housing bubble are "cleansed."

The housing market may be melting way more quickly than I expected. Existing home sales for September showed that sales dropped 3.4% from August on a SAAR basis (seasonally adjusted annualized rate) and 4.1% year over year. Sales dropped to a 3-year low. August's original report was revised lower. It was the 7th straight month of year-over-year monthly declines. The 5.15 million SAAR missed Wall Street's estimate by a country mile. It's always amusing to read NAR chief "economist" Larry Yun's sales spin on the bad numbers, if you have the time.

New home sales for September cratered, down 5.5% from August. This is a "seasonally adjusted, annualized rate" calculation, so seasonality is theoretically "cleansed" from the monthly comparison. But August's original print was revised from 629k to 585k, a rather glaringly large 7% overestimate. The 553k print for September was 12% below the fake August report. Likely a gross overestimate by the Census Bureau plus an unusually large number of contract cancellations between the original report and the revision. But here's the coup de grace: new homes sales for September plunged 13.2% year over year from September 2017. The median sales price plummeted, so "affordability" was less of a factor. And inventory soared to 7.1 months - the highest since March 2011. Hey Larry (Yun of the NAR), care to comment on the inventory report for new homes?

Pending home sales - a leading indicator for existing home sales (pendings are based on contract signings, existing sales are based on closed contracts) - were up slightly in September from August. But August's original pending sales report was revised lower. These numbers are seasonally adjusted and annualized. Pendings were down 3.4% year over year, the 10th YOY decline in the last 11 months.

Never mentioned by the media or highlighted by the NAR reports, "investor"/flippers have been about 15-20% of the existing home sales volume for quite some time. I would suggest that many of newer "for rent" signs popping up all over large metro areas are coming from flippers who are now underwater on their buy, hoping to earn some rental income to cover the carrying cost of their "investment."

At some point, flippers who are stuck with their flip purchases are going to panic and start unloading homes at lower prices. Or just walk away. This was the catalyst that started the pre-financial crisis housing crash in 2007/2008.

The housing market is on the precipice of a large cyclical downturn. My view is that this decline will be worse than the previous one. The Fed injected $2.5 trillion into the housing market to revive it. That heroin has worn off, and the printed money and debt junkie would require twice as much to avoid death from withdrawal. The bottom line is that, despite a 33% drop in the homebuilder stocks since late January, these stocks - and related equities - have a long way to fall. From July 2005 to November 2008, the DJUSHB dropped 87%. It will likely be worse this time, because the homebuilders are bloated up with even more debt and inventory than last time around.