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Back On The Dark Side Of The Homies

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The risk/reward of shorting the homebuilders seems to be back in Boo's favor.

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On Friday I buzzed that I had once again put on a short position in the homies. Long time Minyans know my odyssey with this group, which included getting scorched by the 2004 rally, and a more successful - if far more limited in size – trade in the first half of last year. Since then I have been on the sidelines, suggesting that (i) the fundies in housing have just started to deteriorate; (ii) that when this chapter in the history of financial manias will be written, many homebuilders shares will best be used as wallpaper; but (iii) that I had no desire to fight a stock rally seemingly based on hope and liquidity, a bear's worst nightmare.

As of Thursday however, enough pieces had come together to suggest that the risk/reward of shorting the StreetTracker Homebuilders (XHB) was good enough to jump back in the fray. Here is why in no particular order of relevance:
  • For the last eight months virtually every piece of bad news from any homebuilder was met with a rise in the price of the stocks. However, the reaction to Toll Bros. (TOL) quarterly report, which was touted as being better than consensus, resulted in a decent drop in the stock on very hefty volume.

  • Other homebuilders followed suit and the XHB is again nearing a test of the uptrend with meaningfully deteriorating signals under the hood.

  • The weekly mortgage application index for purchases has taken a drastic turn for the worse since January and the 12 week moving average trend is now negative, not what Hoofy was hoping for as we get close to the all-important spring selling season.

  • While rising interest rates in January probably contributed to the fall off in mortgage apps., the fall in rates since the beginning of February is being attributed to the meltdown in the sub-prime mortgage market, which is now spreading to higher grade mortgage derivatives, if not the underlying paper itself. Not only does the housing market require continued low rates and "dumb and dumber" credit standards just to run in place, but a tightening of credit could quickly lead to a death spiral of foreclosures and plunging home values.

  • When Pimco's Bill Gross is this explicitly bearish on credit spreads, I am going to pay attention, and the consequences for lending in general cannot be good.

  • Around the Washington DC area, "For Sale" signs are popping up like mushrooms. Even assuming a marginally healthy spring selling season, if inventory for sale jumps, prices are likely to take a much worse hit than what has been seen in the broad statistics so far, with the corresponding damage to the psyche (and wallet) of American homeowners.

  • In defending the financial position of his company, Robert Toll pointedly highlighted that by the end of 2007, TOL expects to earn roughly the same net income as it did in 2003. Indeed, indeed: TOL stock price ended 2003 at $20, thanks to the most ebullient sentiment in the history of the housing market, and the prospects of ever rising profit margins. Right now net margins are getting crunched with every sale, and yet the Philly Housing Index (HGX) sits 25% above where it was at the end of 2003.


I suppose that my costly shorting mistake in 2004 was to anticipate a collapse of housing without actually seeing any signs of it. I'll categorize this short position as an effort to avoid missing a potential plunge when all the signs seem to point to it.

Position in XHB
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