Pending Home Sales Upside Surprise: Time to Buy the Homebuilders?

The National Association of Realtors pending home sales index increased by 6.7% to 90.3 in April. This marks the largest increase in that measure in more than seven years and continues a streak of three straight months of strengthening data. Pending home sales is regarded as a leading indicator because it tracks the number of contracts signed, however this does not always translate to a completed transaction. Polling of industry analysts had yielded consensus expectations for a gain of only .5%. Housing is comparatively more affordable now than any time in recent history as housing prices have fallen, mortgage rates hit historic lows, and the $8,000 tax credit for first time home buyers contained within the stimulus plan have all made buying a home more attractive.

Even though pending home sales have improved consistently over the past few months, as of yet existing home sales (recorded when the sale closes) have been much more volatile. Existing home sales were lower in February, increased in March and only slightly increased in April by about 2.5%. The disparity between the pending home sales and existing home sales suggests that mortgages are tougher to come buy as banks have tightened their lending standards. This seems to correlate with recent data suggesting that lenders have not yet resumed lending at a historically normal pace. Either potential home buyers are taking longer to approve or are not being approved at all. However, as Brian S. Wesbury and Robert Stein of First Trust Advisors suggest bank lending is a lagging indicator, but their analysis focuses on commercial and industrial loans to businesses rather than mortgage loans. It would make sense that banks would be more conservative in their mortgage lending practices as well, as capital preservation is still at a premium right now.

The important point in this data is that it shows demand is starting to be pulled back into the housing market. It is on this news that homebuilders are getting a boost; as Hovnanian (HOV) leads the pack up 10% while DR Horton (DHI), Toll Brothers (TOL), Pulte Homes (PHM) are all up as well. However, as you can see from our chart of the Residential Construction sector, we are not at all positive on the stocks in this sector. There has simply been to much of a degradation in earnings and too many balance sheet damaging write-downs that shares have not fallen enough to justify us getting more positive on them.

Furthermore, there is still a huge overhang of supply of housing in the market, and the combination of housing starts having declined very rapidly and this renewed demand is the only way to bring the market back into something of equilibrium and stop the destruction of housing prices. In April, fueled by a record month for foreclosures housing inventory increased 8.8% to almost 4 million existing homes available for sale. That represents more than 10 months of supply given current pace of sales, but the initial buyer’s interest is being drawn into the market which is at least an encouraging sign.

It will be very interesting to see how the rise in mortgage rates will effect these developments going forward. The average 30-year mortgage rate has increased to 5.32% from 4.94% just a month ago. This data is an good sign, but it is still too early to tell if housing is turning a corner. Either way, the earnings potential of homebuilders in an environment where supply is still hanging over the market, makes us want to steer clear of those stocks.

Pending Home Sales Better: Time to Buy the Homebuilders?

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

Ockham Research provides its research in a variety of forms and products including our company specific reports, portfolio analytics tools, newsletters, and blog posts. We also offer a white labeling research solution that can give any financial services firm their own research presence without the time and cost associated with building such a robust coverage universe of their own.

Be the first to comment

Leave a Reply

Your email address will not be published.