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5 Reasons NOT to Own Housing Stocks in 2014

Interest rates are only the start of the problem

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After a blistering 18-month performance, housing stocks have weakened and look to continue underperforming.

Housing stocks were one of the best-performing sectors of the overall market throughout 2012 and the first quarter of 2013, as the real estate market caught some tailwinds thanks to low interest rates, low prices, and a paucity of inventory. However, the sector as a whole has completely stalled since mid-May. While the S&P 500 has climbed 8.3% since May 15, the S&P SPDR Homebuilders Index (XHB) has actually lost 3.2%.

While some builders, like Toll Brothers (TOL) have only suffered moderate losses, the performances of several other builder stocks have been dismal. Lennar (LEN) has been sliced from $44 to $34.17, KB Home (KBH) has dropped from $25 to $16.75, Hovanian Enterprises (HOV) is down from $6.00 to $4.94, and D.R. Horton (DHI) has been hammered from $27 to $19.60.

The XHB, while underperforming the market, is at least doing better compared to those stocks. That’s because the fund has been held up by good performances from stocks that benefit indirectly from the housing market such as Lowe’s (LOW) and Whirlpool (WHR).

A number of factors have contributed to the decline of the individual housing stocks over the last 6 months, including lofty P/E ratios, higher interest rates, the government shutdown and a drop in consumer confidence.

How will the housing stocks perform in 2014, and will they continue to lag the broader markets? I believe the answer to the latter could be yes. Unless conditions change radically, there are five factors that should continue to limit the performance of housing stocks over the next six to12 months:

A rise in the number of listed properties: Abnormally low inventory levels boosted prices throughout 2012 and part of 2013. However, inventories are beginning to rise. The National Association of Realtors (NAR) reported that inventory levels of unsold homes rose in September from a year earlier, the first rise in inventory since 2011. Many homeowners who previously were upside down on their mortgages and unable to sell are no longer under water, as their home values have risen while reducing further loan principal. As a result, more seller-owned homes will be listed for sale, and higher inventory levels should weigh more on demand next year.

The release of shadow inventory: In areas where foreclosures were the highest, like Nevada, California and Florida, banks are now beginning to release more of their foreclosures after holding them back for years in order to stabilize prices. Lower-priced foreclosures, especially on homes built between 2001 and 2008, offer a much cheaper alternative to buyers than new homes, even after factoring in the cost for repairs and cosmetic improvements to the home.

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