Hope for home builders still a mile away
Posted
Feb 19 2008, 07:38 PM
by
Jon Markman
Rating:
The slimmest sliver of hopefulness crept into the gloomy residential construction industry today, as the National Association of Home Builders reported that its index of market confidence has edged higher this month by a single point, to 20. But when you consider that anything below 50 on the scale is considered lousy, it’s plain to see business is still a world of pain.
Home builders’ stocks rallied on the news, signifying that investors may believe some sort of bumpy bottom is now being set in place. Yet it is evident that this is the consensus view, and the consensus has been bitterly wrong about housing for the past two years. So if you want to be a contrarian today, you actually have to expect home prices and home-builders shares will commence to fall from their already low level.
At the risk of sounding like a spoil sport, I actually think that this is likely. To be bullish on home builders as an investor, after all, you need to make two assumptions (and both have to be right): You need to believe that home affordability will materially improve, and that the inventory of houses for sale will materially shrink.
The first assumption is probably correct: Affordability has improved by around 20% from levels in late 2006 due to the Federal Reserve’s aggressive interest-rate cuts in the past two months. According to Morgan Stanley research, another 10% fall in home prices would take affordability back to the all-time high level set in October 1998.
It’s the other assumption that doesn’t work, because there’s a big difference between now and 1998: Back then, when the market did turn, there was only four months of home inventory on the market. Today there’s something like 9.6 months of inventory, according to Morgan Stanley data. That means interest rates have to fall much farther and housing starts have to contract a lot more to wipe out the inventory overhang and allow homebuilders to get traction as an industry again.
Today rates may be low but banks are increasingly unwilling to lend to all but the most rock-solid credits. As a result, investors should continue to be wary of homebuilders shares no matter how tempting they may look now. It may be cheap to get in a new house in Indianapolis, Ind., or Youngstown, Ohio, but just about anywhere else, like Los Angeles or Phoenix, you're out of luck.
And how about the mortgage banks such as Fannie Mae (FNM), with rates falling? Steer clear of them too, since the credit quality of Fannie's securitized loans is deteriorating amid rising delinquency rates. The scariest thing about Fannie is that even its jumbo-loan customers labeled as “prime” credits are bailing on obligations at an accelerating rate, according to the latest data, which can only lead in one direction: More losses for lenders.
