The Recent History And Future Of Housing
Earlier last week Prof. Sedacca started showing some interest for the long side of the homebuilders. On Friday, Prof. Katz also chimed in to point out some hefty insider buying in the shares of Meritage Homes (MTH). On “Fast Money” Prof. Adami has been suggesting a trading long in KB Homes (KBH). That’s three smart cookies on the same side of the table, and when that happens attention should be paid.
I have revisited a bunch of the articles I wrote about the homebuilders since early 2005 to refresh myself on where we have been, how we got here, and where the homebuilders may ultimately end up. Here is the time-line.
- In January 1995, both MDC Holdings (MDC) and Standard Pacific (SPF) gave us the first hints that the fundamental trend was changing, but it made absolutely no difference to the stocks, which were about to enter the last phase of the mania. It was all about the new paradigm of ever rising home prices disingenuously attributed to never-ending demographic demand.
- Yours truly gets blown out of his homies shorts, just as the creative financing of today’s front pages jams more and more crazed buyers into “affordable monthly payments” instead of “affordable homes.”
- Six months later homeowners, including some Minyans, start questioning my and other Professors’ sense that the bubble may be on its last breath. You can almost sense that people know that something is not quite right, but that if they try hard enough to wish the problem away, maybe the illusion can continue. It is the early onset of the denial phase.
- By November 2005 the reports from the homebuilders, Beazer Homes (BZH) front and center, leave no doubt that the party is over, but stock prices at first do not want to hear about it, as companies tap the debt markets in an effort to prop up their stocks. The “denial” phase of the collapse starts in earnest in early 2006.
- The howling from homeowners grows and sell side analysts begin the dance of upping/repeating "Buy" ratings while slashing estimates and price targets.
- Notwithstanding the above, homebuilders' stocks drop approximately 30% by mid-'06. The denial phase of the selling feels over; prices recover in the absence of incrementally worse news.
- By the end of 2006 however, the evidence that things are not improving is irrefutable and D.R. Horton's (DHI) CEO slashes any hopes that the stocks performance in the latter part of '06 might be signaling a fundamental recovery. The disconnect between stock prices and fundamentals becomes obvious and investors "Migrate" away from the sector.
- By August of this year the mortgage debt panic is in full bloom, and after losing 40% from the late '06 recovery highs, homebuilders stocks once again trade like washed-out names.
So whereto from here? The proverbial phases of a bear market - Denial, Migration, Panic - appear to be unfolding in textbook fashion, with the two drops taking approximately half the time of the intervening rally, and the second drop approximately 10% steeper than the first.
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My guess is that, purely as a function of time and price (care to expand, Prof. Cooper?) Profs Sedacca, Katz and Adami's feel for a long trade in the homies is probably right. However, in my view this would be a quintessential counter-trend trade, with all the risks inherent to it.
Between the upcoming positive seasonality and seeming desire by housing stocks to ignore bad news, jumping on the dark side right here and right now has the potential to be at least frustrating. These names need to give holders one more dose of hope before crushing them in the "Panic" phase, which should be swifter and do more damage than the first two down legs.
So what might be the trigger(s) for the panic? In order of likelihood, three things stick out as candidates:
3) Bankruptcy filings by some of the better known publicly traded homebuilders. Standard Pacific would seem to be the front runner based on when its debt tranches are coming due, the terms of the latest $100 mln financing (at the end of 2Q the company's cash on hand was down to $22 mln), and the unbudging wide spreads on its Credit Default Swaps.
2) Writedowns in the companies' "Book Value": as of the most recent financials, BZH stated BV is $42ish, SPF $25 and Hovnanian (HOV) $27. When the CFO's of these companies will finally be forced to accept the realities of the current market, those numbers will likely get slashed in half, and then in half again.
And No.1) Snowballing foreclosures on large, privately-held developments. That's what started the chain reaction of the 1990-'92 commercial real estate debacle. Banks begin to compete with homebuilders for buyers, while prices in the formerly hot markets drop 10% per quarter, and the regulators stand over the shoulders of the banks to make sure that their "Real Estate Owned" gets dumped in a timely manner.
The latter, in my humble opinion, stands out as the most likley catalyst for the final collapse in homebuilders' equity prices (50% from the coming recovery highs?) and should generate the type of desperation and despondency toward real estate that - after some years - will create the right environment for a sustained housing bull.
And of course - as always - I could be wrong.
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