S&P Bets On Housing

By Duru

October 1, 2005


During my causal browsing around the world of stocks, I noticed that housing stocks were on fire the last day of the third quarter. I was quite surprised because the recent technical breakdowns of housing stocks like HOV, LEN, CTX, and TOL (all went below their respective 200 DMAs) was telling me that the market was finally ready to bet on a peak in housing for this cycle. Even more telling was the rampant selling after housing builders announced generally solid earnings results in the past month (the contrast between rosy executives and sour stock traders was particularly bad with TOL and LEN, HOV to a lesser extent). Well, Friday, the market said something else. Lennar (LEN) in particular had a very strong day with high volume and a gap back over the 200 DMA. Sure enough, after the market closed, Standard & Poor's (S&P) announced its decision to add Lennar to the S&P 500 stock index. Friday's strong day tells us that plenty of folks got the drop on the news early. The rest of the universe of index funds and buyers piled into the stock after-hours and sent LEN almost two more points higher in the mad scramble.

It is fairly typical for a stock to pop upon addition to a sizeable stock index. However, after the initial excitement wears off, all bets are off. Given that housing seems to be in the last innings (hours?) of its boom cycle, I would hazard to guess that this latest pop gives shorts an excellent re-entry point. It is even more revealing to look at what S&P did not add to the index. Some folks were betting that Google (GOOG) would finally get the nod now that it qualifies for inclusion (a year has passed since the IPO - can you believe it has already been a year?!?). The stock even gapped up a bit on Friday and sold off a bit less in after hours following the disappointing lack of news. With a market cap of $88B, Google seems like a no-brainer, especially when compared to the alternative of Lennar at $9B. We may never know or understand the S&P's reasoning for this round of changes, but I bet the disaster of the tech stock bubble has given these famed indexers short arms when it comes to reaching for tech stocks. The extreme euphoria back then made many tech stocks simply too big to ignore. The S&P 500 was scrambling adding this and that tech stock to the index. When the bubble popped, the S&P 500 suffered mightily for these late-stage moves. So now, given the option between adding a stock like LEN with a P/E ratio less than 10 versus a stock like Google with a P/E ratio approaching 100, I guess the S&P decided to go for the more conservative play.

But is LEN truly a more conservative stock than GOOG? By all measure, housing looks like an industry headed for a cooling off period. The internet, and especially internet advertising, has experienced a revival of phoenix-like proportions. Since the stock market peaks in early 2000, LEN's stock price has gone up by a factor of 6 (yes SIX!). Judging from the "modern" history of housing stocks, this is an astronomical run of fun. How much would you bet on a similar run over the next five years? Even measuring from Google's IPO, LEN is up a cool 25%. In this time, Google has gone up 270%, and increase in value of almost 4 times. But we all know that as tech stocks go, this run is par for the course for tech companies experiencing rapid earnings and revenue growth. So, in relative terms, you would not be crazy to say that LEN is at best just as risky an addition as Google.

In the end, the S&P will be compelled to add GOOG to the index. Internet advertising is in its early stages of becoming a sustained and viable industry. The continued strength in Google's stock tells me that "everyone" is betting on inclusion. Perhaps afterwards, Google's stock will finally cool down. I am not so sure. Regardless, stay tuned, and be careful out there!


DrDuru, 2005