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Back on Dec 1, I finally accepted that the homebuilder stocks had put in a bottom. Three months later, and an 8.7% decline in XHB, the Homebuilder ETF, and I am now accepting that the homebuilder stocks have punched in a top for now. On Jan 7 and on Feb 23 I took particular interest in clear cases where the market was no longer blithely and automatically buying the bad news that constantly streamed out of the earnings reports of homebuilders. Individual homebuilder stocks were looking worse and worse from a technical perspective. On Feb 23, the XHB was once again challenging the 50DMA support, and right at the upward trend line. This time, support broke, and it broke decisively. The homebuilder stocks are officially broken.
By now, most of you have heard about the growing disaster in the sub-prime mortgage market. I will not go into the details. Plenty of bears have written better pieces on this than I can (Kass: "Subprime Fungus Will Spread" (2/15/07) and Fleckenstein: "Subprime housing game is over (2/26/07)"). The bottom-line is that as the Feds and the banks finally go about cleaning up the mess that easy credit has created and begin to tighten lending standards, a significant portion of the demand for housing will be removed from the list of buyers. In many markets where homes remain unaffordable to the majority of the working population, subprime (and other creative) loans remain the primary drivers of housing demand. This shrinkage could not come at a worse time because homebuilders are still struggling to rein in the supply of homes. Now, with the threat of further declines in demand and the likely parallel increase in (cheap) supply of foreclosures, the homebuilders will have to fast further and deeper than before. The looming implications of this unwinding of easy credit has finally put the market in a sell on the bad news mode. No longer is the market celebrating the bad news as more signs that things cannot get worse or that a Fed rate hike is coming sooner than later. Instead, things do continue to get worse, and the Fed remains in no position to drop rates with inflation pressures still present in the economy.
So, we must declare the homebuilder stocks officially broken. Sentiment has taken a sharp turn southward along with the rest of the dour mood in the market. But we cannot dismiss the weakness in homebuilder stocks as collateral damage from a "healthy" market correction. Instead, we have to remember that this current correction is about the destruction of credit. The players in the subprime market are scrambling to shove these treacherous loans back to the originators, and these companies are getting absolutely crushed into oblivion by the stock market (NEW, NFI, IMH, FMT, etc...). The Feds are investigating and sharpening regulatory regimes. Expect the SEC to start sniffing around as accounting issues are surfacing amongst the worst of the subprime lot. In a telling vote of no confidence, the large British bank HSBC has now sworn off acquiring any more U.S. assets as it suffers from the constipation of acquiriing poor mortgages in 2005 and 2006.
I daresay that the bottom from last summer should hold. At the rate of the current selling, we should see a test of these bottoms very soon. We are seeing the true kind of fear that precedes real buying opportunities. The collapse of individual homebuilder stocks continues unabated. BZH and MHO finally punched out new lows. CTX is testing its 52-week low. BHS finally fell out of the sky with a plunge of 10% that takes it back under the 200DMA. WCI amd KBH are the only major homebuilder that I follow that remain above the 200DMA support. Sure enough, the XHB finally succumbed to the 200DMA today. The uptrend and critical support have been violated - yep, this is official "breakdown" behavior, folks. And it is the hallmark of fear and respect for risk finally returning to the homebuilder stocks.
I am definitely not going to try to predict the timing of the almost inevitable bounce. I have already been singed trying to dabble in a bit of that (only tempered by some dabbling in puts!). Instead, let's take a look at valuation. After all, it was supposedly when the homebuilders hit book value that the buyers stepped up in full force. The following list shows where the homebuilders stand with respect to price/book (P/B) in acending order (from Yahoo!Finance):
MHO: 0.67
WCI: 0.86
BZH: 0.91
MTH: 0.98
MTH: 0.98
MDC: 1.04
HOV: 1.05
CTX: 1.13
PHM: 1.15
TARR: 1.19
DHI: 1.22
TOL: 1.30
RYL: 1.34
LEN: 1.35
KBH: 1.51
BHS: 2.46
I wish I could easily pull out these same numbers during the summer lows, but I suspect we have not yet arrived. There are some big boys still sporting "fat" valuations and lots of air below to the 52-week lows. The market is now being forced to take seriously the prospect of further land option write-offs that will further reduce book value. The market will have to discount book value below one for most of the builders on this list if this process continues. Will we neatly re-test the summer lows? Or crash through them to ignite one more convulsion of fear in this sector? So far, fear is clearly winning. And this is all without the immediate prospect of a recession. I am thinking this sector will remain trapped in some kind of trading range for the remainder of this year. However, if the market does decide to take seriously the prospect of a housing-led recession, then we should definitely look out below...
Need I even say it?!? Be careful out there!