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New Home Sales Data Could Spell Trouble For TOLL BROTHERS INC (NYSE: TOL), KB HOME (NYSE: KBH)

|Includes: KBH, Toll Brothers Inc. (TOL)

New Homes Sales dropped sharply by 11% today as it appears home buyers who wanted the $8,000 tax credit by the end of the year have already completed their purchases prior to the government extending the credit.  Before the government extended the credit, there was a mad rush to complete purchases to take advantage of that benefit.  Now, just like Cash For Clunkers, there is no incentive to buy thus buyers are going to take their time until late next year when the credit is due to expire again.  This will put a lot of pressure on stocks like TOLL BROTHERS INC (NYSE: TOL) and KB HOME (NYSE: KBH).  Inventories of homes in November were at 7.2 months supply which is equal to the supply in October.  This is also a key number to watch.  As inventories drop, home builders will have to start building again as supply decreases. That is not happening.

I expect the weakness in home sales to continue into the first quarter of 2010.  This will have a negative impact, not only on home builders directly but also suppliers of building materials.  HOME DEPOT INC (NYSE: HD) and LOWES COMPANIES (NYSE: LOW) have both outperformed the market recently spiking to 52 week highs.  Both these companies could be in for a rude awakening as the housing recovery has yet to really take hold.  I have to be bearish on them at these levels.

The success to the housing recovery also hinges on interest rates.  Remember, getting a low mortgage rate is directly tied to interest rates that the Federal Reserve states.  The higher interest rates move, the harder it will be for someone to afford that monthly mortgage payment.  Therefore, there will be quite a bit of pressure on the Federal Reserve to keep interest rates where they are.  Should interest rates rise, the housing market would most likely continue to remain on the bottom if not head down even further.

Please note the ugly situation the Federal Reserve is faced with.  Inflation may start to creep in but if they raise interest rates, they kill the economy and the housing market.  What do they do?  Most likely the wrong thing as they have throughout history.  As we all know by now and my partner and I stated years ago when we called for the collapse of housing and the financial system in 2006 and 2007, Alan Greenspan essentially caused the housing bubble to form when he dropped interest rates to save the market after the Tech Bubble burst.  One bubble after the other.  What is the next one?  Treasuries!

Gareth Soloway
Chief Market Strategist