A popular saying among weather forecasters is that March comes in like a lion and goes out like a lamb. However, for homebuilders, March has roared in like a bear — and neither lamb nor bull has showed its face.
Some three weeks ago, after the Builder Confidence Index suffered its worst monthly decline in history — falling in its monthly reading from 56 to 46 — I cautioned that real estate sales could be next. Indeed, the building starts report confirmed that warning the next day, reporting a decline of some 16% from the previous month.
Interestingly, homebuilders and the SPDR S&P Homebuilders Index ETF (XHB) initially shrugged off the bad reports, blaming it on bad weather, and the XHB actually rose another 7% between mid-February and the first week of March. But let’s take a look at the carnage that has developed within the real estate sector since then.
Homebuilders like Hovanian (HOV), KB Home (KBH), Ryland Group (RYL), and Lennar Corp (LEN) have all dropped dramatically. HOV stock was at $6.07 on March 4, the day before a bad earnings report blasted the stock down 10%. HOV’s EPS of 17 cents per share for the fiscal first quarter was 13 cents worse than the Street’s estimates. Revenue was up 1.6% from a year ago, but came in at $364 million, far below the analysts’ expectations of $410.32 million.
As you can see from the accompanying chart, after the initial 10% decline, HOV stock has continued lower for another 5 consecutive days, and closed on Wednesday at only $4.90. The 50-day moving average has already begun to turn lower, which is a negative technical sign.
Even Ryland, which hasn’t had the pressure of a recent bad earnings report and sports an attractive price-to-earnings ratio of only 6, has been hammered lately. RYL stock tanked from $46.59 at the end of February to a closing price yesterday of $41.82 — a drop of 11%. LEN stock has also performed poorly over the same time frame, down 7%.
Like HOV, KBH stock has been through a bear of a month. It closed out February at $20.40 per share, but has steadily declined more than 13% since then. A Bank of America downgrade from “buy” to “underperform” didn’t help, but the stock was already beaten down considerably before that.
Heavy short interest is one of the major culprits (38% of KBH’s float is held short). Another factor was the National Association of Realtor’s pending existing home sales for January, which was basically flat from December, but 9% below pending sales from a year earlier.
Most of the recent bad reports have been blamed on poor winter weather in the Northern states. However, there is real concern among realtors and mortgage brokers in the real estate industry that a genuine slow down in the market is occurring, irrespective of the recent weather. Steep layoffs in the mortgage departments of both Bank of America (BAC) and Wells Fargo (WFC) recently are confirming this anxiety.
Articles in the media citing the inability of the Millennial generation to purchase a home are now becoming more commonplace. Negative factors such as job downsizing, little-to-no savings, heavy student loan and other debts are impeding this generation from leaving their parents’ homes. And that’s bad news for homebuilders.
Higher insurance payments or increasing deductibles from the ironically named Affordable Health Care Act also have the real estate industry worried about millennials’ ability to afford down payments and closing costs on home purchases over the next few years.
As a result, investors have been bailing out of homebuilders and increasing their short positions within the last few weeks.
But is this pullback a buying opportunity, or the beginning of a larger decline? I believe that with the presently oversold condition of these stocks, we will soon see a brief retracement of some of the losses, but it is doubtful that homebuilders will return to their previous highs.
Therefore, homebuilders have now become a trading sector, rather than a long-term investment until things improve in the industry. However, there is one exception. Toll Brothers (TOL) is showing strong relative strength within the homebuilder sector right now.
But even this company, which specializes in “step-up” homes for higher-income earners, could face major difficulties down the road if there are fewer first-time buyers to purchase homes.
My recommendation for long-term investors is to continue to avoid homebuilders. But short-term swing traders may want to consider buying calls or selling puts in anticipation of a short-term bounce. I certainly don’t see this as the pause that refreshes for homebuilders, and I’m not looking for any lambs or bulls to come out of hiding any time soon.
As of this writing, Ethan Roberts did not hold a position in any of the aforementioned securities.