If the housing recovery is on such solid footing, why are many homebuilder stocks already in or approaching bear market territory? Would you believe that since May 2013, the SPDR S&P Homebuilder ETF
(NYSEARCA:XHB) has lost over 12% of its value and the iShares Dow Jones US Home Construction ETF
(NYSEARCA:ITB) has fared even worse, losing over 20% of its value in only three months?
It gets worse.
REITs, such as the Vanguard REIT ETF
(NYSEARCA:VNQ) and the iShares FTSE Mortgage REIT
(NYSEARCA:REM) are in a similar boat, down 20% over the same three months.
What exactly is going on with the housing stocks? And are they warning us something more sinister is brewing in housing’s "recovery"?
The Real Housing Barometer
In March 2013, something happened to the housing industry, but almost nobody noticed.
Lumber prices peaked that month at over $400 per contract. Since then, lumber prices have been in a near freefall, falling over 25% to below $300 through summer. At around $320 today, lumber prices are down significantly from their peak price earlier this year, and that continues to worry us about the housing market.
Lumber has its ups and downs just like any market, but generally, it is considered a leading indicator to the housing market since it’s a key input ingredient.
There also is empirical evidence that supports lumber’s importance to the housing market as significant declines in lumber prices have preceded all the major declines in housing related equities since 2005.
This is why, on May 15, I wrote an article entitled "Timber!"
when the iShares Home Construction ETF
(NYSEARCA:ITB) was still above $25, warning of lumber’s freefall and how it compared to the freefall that also preceded the homebuilder’s bear market of 2011.
Selling anything related to housing after such a large decline in lumber prices was the right thing to do in May, but is it still the right thing to do now?
What About the Fundamentals?
If one ignores the news media and actually looks at the data, the only thing remotely positive about the housing situation is its price index rising and some markets’ re-emergences as "hotspots for flipping and all-cash offers."
Most of the actual fundamental housing data -- such as new housing starts, mortgage applications, and single family housing transactions -- remain well below any of the levels seen in the 2000s (their current levels actually correspond to the levels last seen during the 1990s recession).
The chart below is one I initially included in a follow up article to “Timber,” entitled “Genuine Housing Recovery or Relief Rally?” and published May 29; it is updated through August, showing a few of these housing data points.
Notice that housing’s price index is only back to 2004 levels and that at the bottom, the last few months' housing transactions and new starts have actually started to decline again, something lumber prices warned us of.
More specifically, along with the recent 25% rise in long-term interest rates, single family home starts have actually been declining since February, weekly mortgage applications have been in freefall since June, and month-over-month home prices are now decelerating, not increasing as they were earlier this year.
Fundamentally, housing’s recovery is not on solid ground.
Homebuilders Show Significant Relative Weakness
Homebuilder stocks have also been showing significant relative weakness to the rest of the equity markets.
Compare the 30%+ declines in the housing stocks such as Lennar Corp
(NYSE:LEN), KB Home
(NYSE:KBH), and DR Horton
(NYSE:DHI) to the broader stock market that is only down a few percent from its recent peak, and the housing industry seems to be in real trouble. Couple this with some bearish technical setups, and the recipe is in place for a continued decline in the housing sector.
Some of the setups we are following can be taken advantage of by buying the ProShares Short Real Estate
(NYSEARCA:REK) and also by buying puts or opening shorts on the homebuilders, construction stocks and REITs (NYSEARCA:RWR).
We continue to think the best days are behind us in the housing sector and suspect that equities related to the sector could have another big move down as the fundamental data continues to play catch up to what the lumber and equity markets already know.
Editor's note: This story by Chad Karnes, Chief Market Strategist, originally appeared on ETFguide.com
To read more from ETFguide, see:
Is the Sleeping Giant (Volatility) Ready to Awaken?
Stock Valuations Are Just Dot-Com Bubbly
Getting Paid to Hedge the Gold Miners ETF
No positions in stocks mentioned.