More Positive Milestones For The Residential Housing Market

Includes: TLT, TOL, XHB
by: Duru

The residential housing industry received more positive data on August 29, 2012.

First, the latest Federal Reserve's beige book further confirmed the stronger price trends shown in the Federal Housing Finance Agency (FHFA) data:

"Real estate markets were generally said to be improving. On the residential side, all 12 Districts cited increases in home sales, home prices, or housing construction."


"Housing markets across most Districts exhibited signs of improvement, with sales and construction continuing to increase. Dallas reported significant levels of buyer traffic, Richmond noted strong pending sales, and Minneapolis and St. Louis mentioned increases in building permits. New York, Philadelphia, and Chicago indicated improvements as well, but characterized the progress as slow and modest. Declines in inventory levels were reported in Boston, New York, Philadelphia, Atlanta, Dallas, and San Francisco; these declining inventories put some upward pressure on prices according to Boston, Atlanta, and Dallas. A reduction in the stock of distressed properties was mentioned in New York, Richmond, and San Francisco. In Philadelphia and Kansas City, the possibility of shadow inventory entering the market remains a concern. In general, outlooks were positive, with continued increases in activity expected, although the projected gains were more modest in Boston, Cleveland, and Kansas City."

I took particular note that only two districts expressed concerns over the fresh arrival of shadow inventory. Moreover, a lack of inventory is actually helping to push prices upward in some districts. This expressed inventory shortage is corroborated by claims from the National Association of Realtors in its latest report on pending home sales (for July):

"Limited inventory is constraining market activity. 'All regions saw monthly increases in home-buying activity except for the West, which is now experiencing an acute inventory shortage' …

… Falling visible and shadow inventories point toward continuing price gains. Expected gains in housing starts of 25 to 30 percent this year, and nearly 50 percent in 2013, are insufficient to meet the growing housing demand …"

(For corroboration of the growing demand for housing, see the recent earnings reports of homebuilders like Toll Brothers (NYSE:TOL). For a discussion examining the likely large difference in quality between the stock of shadow inventory and non-distressed homes, see January's look at the highly pressured Atlanta market in "Shadow Inventory Now Much Less Of A Threat To Homebuilders".)

In this same report, the NAR reports an important milestone for pending home sales:

"Pending home sales rose in July to the highest level in over two years…which was shortly before the closing deadline for the home buyer tax credit."

All these data points add more evidence that my long anticipated bottom for housing in 2013 is indeed underway. On the heels of this latest good news, the SPDR S&P Homebuilders ETF (NYSEARCA:XHB) nudged upward a fraction of a percent to a new (marginal) closing four-year high. I would have expected a lot more except that XHB is already up 37% this year and up 91% from the 2011 lows. As I claimed in "Latest Housing Price Data Confirm Housing Bottom Is Underway," the stock market has already well anticipated a firmer housing market. However with fears of a new recession remaining stubbornly persistent, I am expecting any poor data in the coming months to generate sell-offs that provide better entry points for investors that are interested in participating in this bottoming process.

I recognize that celebrating a "bottoming underway" is not the same as declaring a bottom is actually behind us, but I think the caution is warranted given the sickly recovery to-date. I do not yet have a forecast for what the housing market might look like post-bottom (I leave the forecasting to my brother!), but I am not expecting a quick return to the heady days of the prior housing bubble. However, I think it is very valuable to recognize the process of improvement and its positive implications for the future: the market is moving from "things are no longer getting worse" to "things are getting better", and, eventually, "things are going well."

With caution in mind, I decided to read one of the many pieces out there designed to strike fear into the hearts of anyone otherwise interested in buying a home or investing in real estate. This one comes from Agustino Fontevecchia in Forbes, titled "What Housing Recovery? Distressed Sales Still High, Shadow Inventory Massive."

Fontevecchia's core issue is the commonly cited massive numbers on underwater mortgages and shadow inventories:

"With 11.4 million, or 23.7%, of all residential properties with a mortgage under water, and a shadow inventory worth $246 billion, according to CoreLogic, a true housing recovery is far away."

This shadow inventory is currently estimated at 1.5 million units or four months of supply. This hardly seems like a devastating number even in the aggregate particularly if demand is trending upward now. As intimated earlier the quality of much of this stock is likely low. Moreover, I suspect this inventory will continue to trickle out relatively slowly (the article includes an analysis from Goldman Sachs demonstrating the meager impact on pricing from a 2 or 4-year return to historical averages for distressed homes).

Regardless, what exactly is a "true recovery?" The article does not quite define it, but it appears to be the absence of any blemish on the housing market. Even after citing these ominous statistics (and others), the author still concludes the following:

"Housing markets are no longer in free fall, even though there are risks to the outlook. But analysts are turning more bullish. Investors should remain cautious, but should expect prices to very gradually firm going forward. They must note, though, that the market is still more than 30% off its peak, and the rate of distressed properties, while substantially lower than in 2009, is still far above the historical average."

Given where the market has been, this is VERY good news. In fact, I find this conclusion yet another encouraging piece of evidence supporting a bottom for 2013. A "gradual firming" in prices going forward is pretty much the best we should expect all things considered. Recall that the FHFA data show that even the prices of distressed properties appears to be bottoming. For regions where inventories are coming up short relative to current demand, I expect the release of distressed properties to be a non-issue.

The risks to outlooks for the housing market should remain for the next year or so. When/if these risks materialize, they should provide good buying opportunities in housing-related stocks.

On a related note, I sold my calls in iShares Barclays 20+ Year Treasury Bond (NYSEARCA:TLT). It was mainly a technical call playing the bounce from the 200-day moving average (DMA) and selling on a fade from the 50DMA. However, I think absent more manipulation from the Federal Reserve, I am expecting long-term rates to bottom around current levels the longer the economy trudges along without descending into the long-feared double dip recession.

(Click to enlarge)

TLT bounces cleanly off support from the 200DMA but appears stalled at 50DMA resistance


Disclosure: I am long TBT. 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. I am also long housing-related stocks: KBH (with covered calls) and DX.