I watched with great interest as the market got hit with a flurry of housing news. We mainly received confirmation that the industry is still in the doldrums and that things will get worse before they get better. However, the market tried its best to look forward and beyond all the bad.
We started the week with the S&P declaring that: "We do not expect to see a recovery for most rated home builders until 2008, under the best of circumstances. In fact, a rebound could easily slide into 2009 if a subprime contagion spreads to the Alt-A and prime products." This same article quoted a JP Morgan analyst who noted that short interest continues to rise in homebuilder stocks: "...for the 30-day period ended April 10, short interest in home builder stocks...increased to a new high of 18 percent. Short interest rose the most in Beazer Homes USA (BZH), KB Home (KBH), and Hovnanian Enterprises (HOV), builders that JP Morgan suspects have the greatest exposure to the subprime market."
BZH last week provided a great example of what can happen when the shorts crowd into a bearish bet. On the morning of April 26th, BZH reported a loss of $43.1M on the quarter, a 35% drop in revenue year-over-year, withdrew guidance for the rest of 2007, and even reported that it is the target of a second class-action lawsuit regarding fraud in its mortgage origination business. President and Chief Executive Officer, Ian J. McCarthy provided the final kicker: "Most housing markets across the country continue to experience lower levels of demand coupled with higher levels of inventory, resulting in increased competition and continued significant discounting. While we were pleased with the level of new orders we achieved this quarter, at this point in the traditional spring selling season we still have yet to see any meaningful evidence of a sustainable recovery in the housing market, and we expect current conditions will continue to put pressure on homebuilders' operating results." BZH's stock closed with a 5% gain on this news. I clearly under-estimated the market's enthusiasm for the current bounce in homebuilder stocks, as I was already out of the bounce trade in BZH before this report. The market is back in a buying mode and bad news is again being interpreted as an indicator that things cannot get worse. This is an environment where shorts will be forced to cover, and we could see that action in stocks like BZH. Shorts must have been running for cover across the board as the XHB (homebuilders ETF) ran up 3.3% on a day the S&P 500 closed unchanged. And to the point, the XHB lost almost all of Thursday's gains on Friday. However, the upward momentum from the recent bottom continues as Friday's downdraft occured on almost 2/3 less volume than Thursday's bounce. Support at the 50DMA and 200DMA remains intact.
Earlier proof of the building pressure on shorts occured on Tuesday, April 24. That morning, we received news that sales of existing homes dropped 8.4% from the previous month. The headlines were scary, telling us that this was the biggest monthly drop since January, 1989. Homebuilder stocks sold off at first but made a strong recovery into the close. Shorts were officially served notice as the 50DMA and 200DMA both held. Will these shorts help build a bottom here? Perhaps. James Cullen writes a better piece than I could ever write arguing from a fundamental standpoint that some kind of bottom is indeed here. You faithful readers know that I am now taking these bottoms one technical bounce at a time.
One housing-related stock that has not bottomed is Building Materials Holding Corp (BLG). I say that with a tinge of irony since this was the one housing-related bounce play I decided to hold onto last week. I was prepared for about a 10% downside risk on earnings and that is about what I got. However, the bad news bounce was going well until DA Davidson's downgrade drowned out other analyst commentary and sent BLG's stock on a wicked intra-day reversal. Clearly, the near two-year downtrend is well-intact, but the reasons for looking forward to a bounce have not yet changed. The next two to three months will determine whether the upside thesis can overcome the on-going selling pressure.
On the lending front, both IndyMac Bancorp (NDE) and Countrywide (CFC) survived earnings on Thursday - no doubt contributing to (or benefiting from?) the general run-up in housing-related stocks on Thursday. I decided to start legging back into NDE again before earnings, and, so far, so good. The stock is still making higher lows, but the bounce from the recent bottom now needs a higher high soon to remain convincing. As a reminder, NDE is mainly a play on the confidence insiders have shown by buying up large tranches of NDE stock during the recent sharp correction.
Finally, we ended the week with a report that last quarter had GDP growth of 1.3%. This growth was much lower than the expected and the lowest quarterly growth rate in four years. The main culprit turned out to be a 16.7% drop in residential fixed investment (basically, housing) that took out a 0.97 percentage point chunk from GDP. Given that this drop was bigger than expected, we should wonder whether folks are truly grasping how bad the housing decline has been and, by extension, whether the stock market has truly priced in how much worse things could get. In other words, this should serve as a note of caution for anyone wanting to declare the worst is over for housing. Ironically enough, it was consumer spending that saved the day with 3.8% annualized growth in spending - despite the huge drop in the housing sector that has supposedly bolstered consumer buying power. Assuming that the savings rate of Americans is still negative, the robust consumer spending serves as another reminder of how dependent the economy is on growing more and more debt. The continued buoyancy of the consumer is also helping to maintain inflation at levels higher than the Fed's comfort level (robust consumer demand is also helping to keep gas marching toward ever higher levels).
The spring buying and selling season is now in full swing. The homebuilders were generally very downbeat about their expectations, and there is every reason to believe that sales will be bad. (For more tales of woe, click here for an article talking about the surge of foreclosures in areas like Las Vegas that experienced the most excessive speculation.) Homebuilder stocks will not be able to survive a general market correction under these conditions...so, watch for the "sell in May" syndrome, and, as always, be careful out there!