Home Builder Confidence Weaker; Supply Side Still an Issue

The National Association of Home Builders/Wells Fargo Housing Market Index missed consensus expectations by two points, slipping to 59 against the Bloomberg projection of 61.  The index had held steady at 58 for several months before leaping to 60 in June.  While an index above 50 shows that builders are optimistic about single-family housing, there are still some underlying issues in the industry that are keeping that optimism in check.

The ratio of new homes to resold homes has dropped to 1.2:1 from a high of 2:1 in the 1970s.  There are numerous factors involved, however as more and more homeowners exit an inverted status that resulted from the real estate crash, that ratio will likely drop even further.  Home sales and housing prices have increased dramatically in recent months due to the continued low interest rates.  This will increase pressure on the industry when rates finally start to normalize, although at this point we're likely looking at mid-2017 before there's any change of significance to the 30-year.

According to Ed Brady, chairman of the housing market trade group, “We are still hearing reports from our members of scattered softness in some markets, due largely to regulatory constraints and shortages of lots and labor.”

Supply side problems have been a consistent theme throughout 2016.  Fannie Mae Chief Economist Doug Duncan lamented in February, "The supply from the builder perspective is just not back to normal. It's up from last year, but it's still below what long-term demographics would suggest, particularly in the lower price points of housing."

Not all regions have fully recovered from the housing crisis, and underwater mortgages coupled with long foreclosure timelines continue to add pressure to the overall supply side of the equation.  With demand continuing to rise, housing prices will also continue to experience a steady increase.  That will aid homeowners still struggling from upside down mortgages, but it certainly will not assist new home builders.  Add the prospect of interest rate hikes in 2017 to the mix, and my expectation is a weakening of the overall Home Builders Index as 2016 progresses.

All of this is good news for the home improvement industry, of course.  Companies like Home Depot (NYSE:HD) and Lowes (NYSE:LOW) will continue to benefit as homeowners choose to maintain and refurbish their properties rather than trade up to new properties.

Housing Starts are released tomorrow at 8:30 AM EDT.  That report should paint a more complete picture since it deals with the actual start of construction as well as the actual number of new permits in flight.  Consensus estimates for Housing Starts is 1.170 million, up from 1.164 million, and for Housing Permits it's 1.150 million, up from 1.138 million.  It's important to note, though, that the rate of new permits has been weakening year over year, adding to the overall struggles in this industry.

Keep an eye on the performance of these three numbers (Housing Market Index, Housing Starts, Permits) over time.  They each have a direct impact on the overall performance of the stocks in the Home Improvement Retailers Industry.  While we, as short term traders, do not focus on the fundamentals, knowing the overall pressures on the stocks in a particular industry does give us that slight edge we need over the competition.

Happy Trading