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Buying Homebuilders Just Doesn’t Make Sense


Sometimes things don’t just seem to make sense.

Stanford beating USC in football…

The Tampa Bay Rays in first place in the American League East…

Watching Brett Favre play in a New York Jets uniform…

All things that make me shake my head in wonder.

Here’s another: the SPDR Homebuilders ETF (XHB). This exchange traded fund is up roughly 50% since mid-July.

Now what on Earth can account for such a move?

Obviously, bargain hunters are stepping up to the plate.  Everyone is taking a guess that we have seen the bottom in the home market.

The problem is that I just don’t see any bargains in the housing sector right now.  Those investors who are speculating on today’s stocks are truly catching knives.  So far they have avoided any injury, and in fact have been rewarded for their bravery.

But Will the Trend Continue?

The news that continues to emanate from the homebuilding industry has never been bleaker (well, at least since the Great Depression). Just last Thursday, the company that is seen as the strongest of the builders, Toll Brothers (TOL), reported a dismal third-quarter with revenue plunging 34% from a year ago, while net contracts on new homes fell by 27% (see, “Toll Brothers (TOL): Nothing to Write Home About“).

A day earlier Hovnanian Enterprises (HOV) reported its fiscal third quarter loss more than doubled from a year ago and it also saw steep declines in revenue, new contracts and home deliveries.

What happens in the overall economy in the future will determine if a bottom has been set.  Right not, there the news is conflicting at best.

Conflicting Economic Data

The Labor Department said the unemployment rate reached a five-year high of 6.1%. And the small gains we are seeing in personal incomes are being eaten up by rising inflation even if gas prices have come down some (see, “How to Profit From Out-of-Control Inflation“). Many Americans simply don’t have the wherewithal to buy new homes, or even make payments on their existing ones.

Second to my concern about the economy is the…> mortgage market. Last week also brought a report that the new source of trouble in this market has shifted from subprime loans made to people with poor credit, to homeowners who had good credit but utilized loans that featured ballooning monthly payments.

These risky adjustable-rate prime loans came in many forms including “interest only” and “pick-a-payment” where the loan balance can actually rise. Now as prices are falling many of the homeowners, who took out these exotic mortgages owe more than their house is worth.

The Mortgage Bankers Association said that more than 4 million homeowners with a mortgage (or 9%) were either behind on their payments, or in foreclosure at the end of June. That is up from 8.1%  at the end of the first quarter and from 6.5% from a year ago. New foreclosures rose in the second quarter in 35 states and Washington, D.C., with the biggest increases being in states such as Nevada, Florida, California and Arizona – states in which the homebuilders saw their biggest profits during the bubble.

Fannie Mae and Freddie Mac Bailout

This week Credit Suisse lowered its rating on the homebuilding sector to “market weight” from “overweight,” because it says it sees further declines in traffic throughout late summer, and markets that had shown signs of life previously slipped in August. “Traffic continues to slip and will likely lead to further price cuts and impairments this fall,” they said.

The government’s bailout of mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) likely won’t help stem the tide of foreclosures (see, “Fannie-Freddie Bailout: What It Means to You“). Many people simply don’t qualify to have their loans refinanced given that their loan balance exceeds the value of their homes, or they simply lied about their incomes on the loan application (there’s a reason they’re called liar loans).

Adding to builders’ woes is the fact that many foreclosures are located in prime locations near employment centers and not 50 miles from town where many new homes are being built. High gas prices will keep a lid on new home prices for the foreseeable future. Until delinquencies and foreclosures begin to reduce significantly, which they are showing no signs of doing, builders will struggle.

Builders (and Realtors) speak of “pent up demand” to buy homes. Of course there is. Who doesn’t want a brand-new house? But there is also pent up demand among sellers who would like to put their homes on the market but have put it off until the market shows signs of rebounding. This number cannot be accurately gauged, but rest assured, they’re out there.

If you must try to play a rebound in the homebuilders, I suggest you buy the ETF mentioned above, for diversification. Among individual builders, Toll Brothers (TOL) – despite its recent woes – is still a solid company and caters to a more upscale buyer. Meritage Homes has a large presence in Texas which has largely escaped the meltdown.

Buying homebuilder stocks today requires one to accept higher valuations at a time when the market is still exhibiting weakness.  In the short run, the homebuilders may drop in value as early speculators take profits.

In the long run, though, the homebuilder sector may actually be worthy of a speculation.

This article was written by Jamie Dlugosch, contributor to For more actionable insight likes this, go to:

Article printed from InvestorPlace Media,

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