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Home sales were very strong last week, but they kicked off a market sell-off

|Includes: SPDR S&P 500 Trust ETF (SPY)

Despite very strong earnings results so far (more than 2/3 of companies are bearing analyst estimates), a seemingly strong sales report on existing homes that came out at 10AM this past Friday kicked off a sell-off starting with financials and homebuilders and extending to the rest of the market.

The annualized seasonally-adjusted home sales volume for September 2009 was 5.57mm vs 5.09mm in Aug and 5.10mm a year ago.  On a raw basis (not seasonally adjusted), the home sales volume was 5.66mm vs 5.98mm in Aug and 5.26mm a year ago.  Also, home inventories were down 15% from 4.27mm a year ago to 3.63mm. 

The ratio of inventories-to-sales is the so-called "months inventories" or "months supply" ratio, which economists and investors monitor closely.  The market is in balance and home prices stabilize when the available inventory accounts for 6-7 months of sales activity.  If more inventories are available, the expectation is that owners will have to offer discounts in order to move them, and prices will be pressured.  In November 2008, the months supply was 11.0, but currently it is at a more balanced 7.8 months -- down an impressive amount from 9.3 months in August.

With strong sales numbers and low inventories, the market seems to be normalizing and to be close to a turning point.  So, why did the stock market start selling off? (the S&P500 is down 2.25% since Friday's open)

The bad omen in the National Association of Realtors (NAR) report was that, even though sales volume increased rapidly, the median home price actually went down.  Usually, when sales pick up and supply is drawn down, prices tend to rise.  In fact, prices have been trending steadily lower since June and were down 1.4% from August and 3.9% since June.  This means that the majority of buying activity is happening at the lower-end of the price spectrum, which indicates primarily first-time homebuyers.  Indeed, first-time homebuyers accounted for a high 45% of sales, according to NAR.

The criticism is that the sales activity is being driven exclusively by government programs.  The Federal Housing Administration requires only 3.5-10% downpayment, even when buyers have FICO credit scores below 500 (the FICO score is an aggregation primarily of payment history, credit utilization).  In conjunction with the government subsidy offering $8,000 to first-time homebuyers, this means that these buyers can purchase homes worth up to $80K - $229K (depending on the FICO score and downpayment range under the FHA program) with no money down.  No wonder that sales volumes have picked up in the lower-end of the pricing spectrum. 

Looking through the report though, investors remain very concerned that there is no real incremental organic demand to support home prices, and are concerned about what will happen when government support for housing dries up.

Disclosure: no positions