Macro Wrap – Homebuilders Can’t Buy a Bucket, $PHM, $XHB

by Enis July 29, 2013 7:54 am • Commentary

The homebuilding stocks have been whacked in the past couple months.  They can’t buy a bucket even with the broader market holding up quite well.

We haven’t liked the homebuilders on a fundamental basis for many months now.  Here is what I wrote in my Macro Wrap post on February 20th:

 Here are 3 brief points on why I’m bearish on TOL and U.S. homebuilders as a whole:

1)  This is a housing recovery, not a housing boom.  The housing market has clearly improved in the past 12 months, but TOL’s current selling pace in its communities is still below its 25 year average
2)  Meanwhile, the stock is priced for more than a boom.  The stock is trading at 2005 levels, when the stock earned more than $4 per share.  In 2013, it’s slated to earn around $1.
3)  Relative valuation for other sectors much better than homebuilders like TOL.  If you want to get long the U.S. housing market, buy Toyota or Ford.
Moreover, a lot of the enthusiasm about the housing market has been focused on selling prices and overall sales.  But new home sales has persistently lagged existing home sales.  In other words, the housing market’s improvement has mostly been driven by clearing longstanding inventory among homeowners, rather than significant demand for new homes.
The chart of annualized New Home Sales since the peak in 2005:
New Home Sales, Courtesy of Bloomberg
New Home Sales (in thousands), Courtesy of Bloomberg

New Home Sales, despite their recent bounce are still around mid-2008 levels, and more than 50% below the 2005 peak.  In contrast, the bounce in existing home sales over the past few years shows a much improved market:

Existing Home Sales (millions), Courtesy of Bloomberg
Existing Home Sales (millions), Courtesy of Bloomberg

The Existing Home Sales figure is around the mid-2007 level, and only about 30% below its 2005 peak.

Existing Home Sales make up a much larger portion of total sales in the housing market, so it’s a much more important figure for overall economic activity in the U.S.  In that sense, the housing market is much healthier than it was 2 or 3 years ago.  But for the homebuilders, new home sales is arguably more important, as they are the ones building and selling the new projects.

The stock charts of stocks in the homebuilding sector reflect that dichotomy.  The major homebuilders (TOL, DHI, LEN, PHM, KBH) are all now trading below their 200 day moving averages after last week’s weakness.  PHM led the move lower after a weak earnings report on Thursday.  The company’s orders fell 12%, and management, though remaining optimistic, voiced caution about its new community growth.  Here is its chart:

Daily chart of PHM since 2011, 200 day ma in black, Courtesy of Bloomberg
Daily chart of PHM since 2011, 200 day ma in black, Courtesy of Bloomberg

This weakness in the homebuilders has led to overall underperformance of XHB vs. SPY, which Cam Hui pointed out in his blog post last week:

On a a relative basis, XHB staged a relative rally from the Eurogeddon lows of 2011, started rolling over in early 2013 and now has violated a relative support level.

Now consider this recent post from Barry Ritholz about private equity seems to have gone overboard on the “rent to flip” in US housing. Mr. Market starting to get nervous about housing, especially if mortgage rates rise any further.

Interestingly, XHB is mostly retailers and appliance companies catering to the homebuilding or renovation industry.  It has actually held up much better in 2013 (up 11%) than the homebuilders (mostly down on the year).  Once again, that’s likely a reflection of the strength in the existing home market (where renovation and home improvement demand remain strong), and weakness in the new home market.

The recent rise in interest rates will likely affect the end market for housing much more than the renovation market, further widening that gap.  How much of that is already reflected in the stock prices is always a key question.  But the business trends going forward still don’t support the investing thesis for homebuilders overall.