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

Slight Decline in Housing Market Index Attributed to Weather

The National Association of Home Builders/Wells Fargo Housing Market Index (HMI) was released this morning, and showed a slight decline from last month's release.  Builder confidence for newly built single family homes dropped to 55, measuring a two-point decline.  The drop, however, is being attributed to the unusually high amount of snow that has blanketed much of the nation for the past month.

Despite the decline, expectations remain very optimistic for a robust building market in the US, once the weather situation improves.  Sales expectations for the next six months remained steady at 60, and it has been hovering in that range for some time.

Interestingly, the Home Construction sector has apparently reached that same plateau.  Take a look at the weekly chart of the sector:

Notice that it formed a wedge with a very slight upward bias starting in the spring of 2013.  The Sector is currently trading at its highs, at least through this decade, but it's showing no signs of attempting to penetrate that channel pattern.

I don't share the optimism being expressed in the Index.  Interest rates are currently low, but they will be increasing this year.  Home Construction appears flat to me, not increasing, and it's not showing any signs that it's ready to do so.  The question is what will drive those projected sales for new home constructions, since current behavior does not support the optimism.  The share of new homes being purchased by first-time buyers is at its lowest level since 1987.  Given the job market, lack of salary increases, and tight capital constraints being imposed on banks, don't expect this behavior to change anytime soon.

What is growing is the construction of rental apartments and condos, and its to those that first-time buyers are going and it's also where the aging home owner is going.  When you look at the number of homes for sale, and in this area the number of For Sale signs in each neighborhood is astonishing, it's quite apparent that there's a significant migration within the current housing market.

Now, that's not all bad news for the housing sector, nor is it bad news for the home suppliers and construction companies.  Whether or not a home is new, a buyer moving in immediately wants to put their touch on it. That's great news for companies like Home Depot and Loews that do well whenever homes change ownership.

The point is, don't rely on New Home Sales numbers to gauge the health of the construction business.  There was a time prior to the housing bubble when that was a significant measure of the sector, but the behavior of the consumer has changed and we, as traders, must therefore adapt.  A better measure would be New and Existing Home Sales, published monthly by the National Association of Home Builders (NAHB).  I also really like the Remodeling Market Index, which is also produced Monthly. This report is a great indicator of how the consumer is behaving, and it drives the performance of a number of industrial and cyclical corporations.

We are in a new post-housing bubble market, and the metrics we used prior to the bubble bursting no longer apply.  As traders, we need to adapt to the behavior of the consumer, and at present, that consumer is moving into condos or rental apartments, not necessarily new homes.  There's profit to be had here if we're willing to adapt to the new metric.