Shorts Press Bets Against Housing

By Dr. Duru written for One-Twenty

August 2, 2006

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I have been amazed as I have watched the psychology on housing slowly turn from buoyant expectations of more boom to be had from 2005 and beyond to the current situation of dour expectations for a crash anytime soon. The CEOs and CFOs of the homebuilders have finally converted from unabashed cheerleaders and rose-colored optimists to reluctant realists and sober stewards of leaky ships. It has been a while since I have written anything about the publicly traded stocks in the housing sector, and I definitely have a lot of catching up to do as most of the stocks I follow have continued to put in new yearly and multi-year lows since I last wrote about them cratering in early June.

What rekindled my interest is noticing Tuesday's relative strength in many of these stocks. Even as the S&P 500 was selling off, the homebuilder stocks were either in rally mode or bouncing strongly off the lows for the day. A few stocks, like Lennar (LEN), Hovanian (HOV), Centex (CTX), and Brookfield Homes (BHS) actually had decent upside gains on the day. The S&P 500 closed down 0.45% on the heels of a late-day rally. Next, I looked at the long-term interest rate scene to see whether that could explain the relative strength. Indeed, the yield on the 10-year treasury has been falling straight down for a month. It is now challenging the low from June, and, once again, has left the long-term downtrend in rates intact. (If I had more time, I would post charts. I hope to provide a more complete technical and fundamental review of this sector in the coming weeks). Tuesday was no exception. Despite economic data incdicating persistent inflation, the yield on the 10-year fell again. The bond market clearly fears that the Fed will kill the economy more than it fears the spectre of inflation. This pits the bond folks directly against the Fed that has claimed in recent months that inflation is creeping too high.

Anyway, the irony here is that lower rates (or at least rates that cannot hold water above 5%) buttress the housing market even as it seems economic growth may finally be ready to cool off. This allows both bears and bulls to place their bets on housing as their biases dictate. Currently, it seems the bears are willing to increase their bets. I did a quick review of short-interest ratio (percentage of stock float) to compare to the numbers from May that I cited earlier. I used Yahoo!Finance to get the numbers from July 15. (Eventually, I hope to track down complete numbers over time). Here is what the short story looks like now. The numbers in parentheses represent short-interest as a percentage of float from May, 2006 if I recorded it:
  1. BHS: 20.3% (n/a)
  2. BZH: 17.0% (20.30%)
  3. CTX: 8.6% ( 7.80%)
  4. DHI: 3.6% (n/a)
  5. HOV: 31.9% (14.80%)
  6. KBH: 11.1% ( 9.50%)
  7. LEN: 7.3% ( 7.70%)
  8. MDC: 14.8% (n/a)
  9. MHO: 17.6% (n/a)
  10. MTH: 18.1% (13.90%)
  11. PHM: 9.3% ( 7.60%)
  12. RYL: 13.7% (n/a)
  13. TOL: 12.1% (11.10%)
Of this sample, only LEN and BZH have seen declines in short-interest ratios and BZH remains at extremely high levels. DHI stands out as being particularly low considering that its last earnings report may have been one of the worst of the group; the market took the stock down as much as 10%, and, unlike most of the other stocks, DHI has not recovered from its most recent beating. The majority of these short-interest ratios are in the double-digits, with two stocks above 20%! Folks, these are very high numbers. The difference in intensity of the shorting and the differences in rate of change probably reflect differences in the economic prospects of these companies. If I had more time, I would present the charts and give another summary of the latest pronouncements from these companies; much of the news coming out in the past 6 weeks shows continued detereoration in the housing sector's outlook. I hope to do a review in the coming weeks. Until then, note that a relief rally may already be underway that will force, or already is forcing, shorts to begin closing out. I can only assume that given the high levels of short-interest reflected here that most will try to hang on at least through the next Fed babble next week.

Regardless, it is clear that the shorts have been willing to press their bets over the past few months. How much worse can things get? Well, if the Fed succeeds in killing the economy, things can get worse. If inflation continues to rise even as wages fail to catch up and housing prices remain stagnant, things WILL get worse. There are few precious catalysts for housing now...especially considering that the current malaise only looks bad when compared to record-setting levels from 2005. Housing activity is still relatively strong compared to historical norms (albeit inventories have been rising, and we saw a very large drop in fixed investment last week). So, while I think the homebuilder stocks are on the cusp of a mini-relief rally, I would not recommend interpreting such a rise as the sign of a bottom in these stocks (recall that even I finally gave up on calling a bottom back on May 12th...which just happened to coincide with the top of the year for the major stock indices). The trend is still down, the economic outlook is worsening...sell/short the strength until the trends get broken or until key resistance levels get broken and successfully re-tested as support...

Be careful out there!

DrDuru, 2006