Eulogy for the "Bottom" in Housing Stocks

By Dr. Duru written for One-Twenty

May 23, 2006

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The last fading hope for a bottom in housing stocks "died" on Monday. Bank of America dealt the death blow as it knocked down the whole homebuilding sector. This is nothing new in the imminent squeeze on consumer spending. However, BofA took aim at Meritage (MTH), the last homebuilder stock (in my universe) that had any semblance of health - if you want to call it that:

"BofA reiterates caution on Homebuilding sector, and reduces targets approx. 20% on average, and cuts ests as they now expect Y06 to show 5% growth YoY, down from 8% previously. Firm sees continued risk to Y07 with high material costs and weaker home pricing. Firm says meaningful weaker home prices could lead co's to trade down through their book values. Firm notes that a pushback of bond yields and a Fed pause would create a near-term rally as seen in '95 and '00, but firm needs to see an economic pickup at the same time to make them more interested in the stocks. Firm cuts their tgts on the following cos : NVR to $500 from $650, TOL to $24 from $27, MTH to $48 from $49, CHCI to $7 from $10 and HOV to $33 from $40." - from (May 22, 2006)

I highlighted MTH earlier this month as I began to concede defeat on the housing stock bottom thesis. At the time, MTH had delivered surprisngly good results and issued a generally bullish forecast. The market actually responded with a vigorous 8% rally. However, MTH could never conquer the all important resistance of the 200DMA (another point of note for those of you who do not believe in technical analysis!). This was the first sign of trouble. The fading volume and long upper wicks on the "candles" were the seal of doom. BofA's downgrade had the predictable results in a market that has turned sour in general. The last shreads of optimism fled MTH and homebuilders in general:

Meritage chart

The latest selling in the homebuilder stocks has occured even as Treasuries finally rally in anticipation of a slower economy. In my last missive on homebuilder stocks, I drew out the interest rate scenario. I figure now it will take a sustained decline in interest rates to save the housing sector from the ravages of crimped consumer spending, the ever-lower affordability of homes, and a slowed (recessionary?) economy - or at least the market's expectation of such events. I also explained what I think went wrong with the "bottom" thesis: we never had a moment of despair that brought out panic selling. In fact, the selling and decline in homebuilder stocks has so far been quite "orderly." It has been a very long and drawn-out eulogy to some kind of end. Until some true bottom-creating event occurs, we should see several more false rallies in these stocks as waves of new optimism re-lift stocks to levels that allow sellers to get out who missed higher prices the last time around.

In other words, be careful out there (as always)!

DrDuru, 2006