Daily Gains Letter

Three-Year Home Price Rally a Half-Truth?

By for Daily Gains Letter |

Why the Housing Decline Is No SurpriseHousing prices were shooting up since 2011, as if a downslide would never return to the housing market. Meanwhile, my colleagues and I warned investors of a slowdown in activity that could jeopardize the housing market. The authorities at the Federal Reserve then were confident of an economic recovery and took increasing housing prices as a bellwether of economic progress.

During the last winter, home sales declined sharply and everything was blamed on the frigid temperatures, implying the housing market would grow once the season was over and done with. When I last wrote about the U.S. housing market, I noted why it was going to be a big disappointment—this was the time when the majority of investors anxiously waited for the spring tide to kick in, so they could compensate for revenues lost during the winter.

The Federal Reserve, too, was confident of a rebound in the housing market at the turn of the season, but since that never happened, it compelled Fed Chair Janet Yellen to come out last week and mention what we have been predicting in our previous issues. Although she provided an upbeat outlook on the overall economy, her major concerns hovered around the housing market, which she now feels is a bit of a red flag. (Source: Kurtz, A., “Janet Yellen’s Big Concern: Housing Slowdown,” CNN Money web site, May 7, 2014.)

Investors generally overlook hidden numbers in the markets and invest on superficial data that surface in the news headlines of the financial dailies. While following the news might not be that bad of an idea, sometimes, the easily available data can lure you into making decisions that are not healthy for your portfolio. Similar patterns in the housing market have induced investors to go bullish on homebuilder and home improvement stocks.

Since 2011, the majority of financial commentaries and economic data releases concentrated on home sales increasing in the U.S.—this created an air of optimism around the housing market and investors jumped in to collect profits. But during this short-lived upsurge, they tended to miss factors that were important in the context of long-term growth and sustainability.

Let’s analyze what these factors are and how they could possibly impact the markets.

Existing- and new-home sales increased by 27.8% and 36.0%, respectively, between 2009 and 2014—but more interestingly, these figures have declined by 5.78% and 13.3%, respectively, during 2014 so far. (Source: Federal Reserve Bank of St. Louis web site, last accessed May 9, 2014.) The housing affordability index fell by 16.7% between 2013 and 2014, while housing starts decreased by 7.1% during 2014, after rallying 77% in the five years leading up to that point. (Source: National Association of Realtors web site, last accessed May 9, 2014.)

The only housing indicator surging in 2014 is the Case-Shiller index, which measures housing prices in the United States. The index jumped 1.55%, after increasing 14.1% in 2013 and 2014 cumulatively. (Source: Federal Reserve Bank of St. Louis web site, last accessed May 9, 2014.)

These statistics tell you the entire story: home prices, although still increasing, have been on a decreasing trend in 2014. Home sales, housing starts, and affordability have all declined, sending strong signals that homebuilder and home improvement stocks will not be seeing high demand in the coming months. This can prove devastating for investors looking at the housing market run of the last five years since the lesser-available, recent data point toward the complete opposite of what they’ve been led to believe up to this point.

As I previously mentioned, homebuilder stocks like D.R. Horton, Inc. (NYSE/DHI) and Toll Brothers, Inc. (NYSE/TOL) were good short candidates. While both of them still hold their utility as possible shorts on the housing market, investors can consider adding a stock like PulteGroup, Inc. (NYSE/PHM) to their portfolios to further extract profits out of the housing market decline.

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