Time to Start Nibbling on Housing Sensitive Stocks

With new home sales down 32.7% in May, the housing bears are once again gaining an audience with the media. While there is little doubt that housing remains in the doldrums, I am getting increasingly bullish at today’s levels and believe that investors with a longer-term time frame (at least 1-2 years) should think about dipping their toes into housing related stocks. The 30%+ declines in many homebuilders over the last few months provides an attractive entry point for those willing to look past that bevy of seemingly bad news over the last few weeks.

Firstly, the huge swoon in May largely reflects the falloff in activity post the expiration of the $8,000 tax credit on April 30th. Homebuilders aggressively built inventory in the first four months of 2010 in anticipation of pulling would be buyers into the market. As such, we saw new home sales increase by 12.1% in March and 14.7% in April, so naturally we were going to see a steep decline in May. Admittedly, 33% was worse than most pundits expected, but I firmly believe that May’s print will represent the trough in this brutal 5-year housing downturn. To put the 300,000 new home sale in context; this is 8.8% lower than the previous lowpoint (329,000 annualized homes sales in January 2009 – two months after the first tax credit was slated to expire) and a staggering 78.4% below the peak number set in July 2005.

Secondly, the standing inventory of new home sales continues to hit cycle lows (see chart below). In my opinion, this represents a more critical data point to gauge the health of the housing market, since the actual sales number has been significantly distorted by the expiration of the tax credit. May inventories were down 26.7% year over year, 62.7% from the cycle peak hit in June 2006 (nearly one year after the peak in new home sales), and lower than any level since data was first recorded in 1970. So while it is difficult to gauge when sales will pick up with any vigor, the low level of standing inventory suggests the industry is in a substantially healthier position and could realize some unexpected pricing power when things inevitably begin to pick up. A good article in today’s Wall Street Journal ("Beaten Down Markets Finds New Fans") highlights the rapidly declining inventory of finished home lots in several of the nation’s most overheated housing markets. Rising land prices inevitably serves as a precursor to higher home prices.

Affordability also should provide another floor on both pricing and volumes. With a peak to trough decline of 33% in home prices (see chart below) and mortgage rates under 5%, today has never been a better time to purchase a home for those waiting patiently on the sidelines. Further, the government remains extremely supportive of the housing market through its 1) commitment to keep long-term interest rates down (however, distortive these actions may prove to be); and 2) its backstop of the mortgage program through the FHA and GSEs. My firm believe is that the government will continue to flood the market with liquidity should evidence of a double dip begin to gain more traction. Multiple speeches given by Bernake suggest that he will do whatever it takes to stabilize the economy no matter how damaging said actions are on the federal balance sheet.

 

In conclusion, while concerns in housing have begun to resurface, I think the structural rebalancing that began in June 2005 is nearing its final stages. As with any market, the tendency to overcorrect is highly probable and investors should expect significant volatility over the coming quarters. However, my bias is always to invest when valuations have troughed and fundamentals have meaningfully improved.  The upside to today's dismal new home sale number is that the data could hardly get any worse; given how difficult the housing space space has been for the last 5 years that in and of itself is cause for celeberation.  For those with a longer-term time frame, investments made at the bottom of the cycle should prove prescient in years to come.