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Why Housing Stocks Are Not Quite What They Seem

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Housing Stocks Are Not Quite What They SeemWe have continued to see strong data pointing to a rebound in the housing market. The latest report from CoreLogic, Inc. (NYSE/CLGX), a research and analytics firm, is that, in October 2012, home prices, including distressed sales, jumped up 6.3% nationwide. This is the largest increase for home prices since June 2006. This was not a one-time jump for the housing market, but the eighth consecutive month of year-over-year nationwide increases in home prices. (Source: “CoreLogic Home Price Index Marks Eighth Consecutive Month of Year-Over-Year Gains,” CoreLogic, Inc., December 4, 2012.)

The question is now beyond whether or not the housing market is off the bottom, but rather: is it too late to invest in homebuilder stocks? Many homebuilder stocks supported by this rebound in the housing market have skyrocketed this year. However, investors should be aware that a large part of revenue for homebuilder stocks is not from actually building homes but from financing them.

This strange artificial interest rate environment that the Federal Reserve has created to entice people back into asset classes, such as the housing market, is creating a boom for homebuilder stocks that have a mortgage-lending division.

As an example, PulteGroup, Inc. (NYSE/PHM) had an increase in mortgage revenue by 70% in the third quarter of 2012 as compared to year-ago levels. Many homebuilder stocks are seeing similarly massive growth levels in their mortgage-lending businesses. (Source: “Homebuilders Boom as Lending Masks Uneven U.S. Recovery,” Bloomberg, December 10, 2012.)

PulteGroup Inc Chart

Chart courtesy of www.StockCharts.com

By looking at the chart of one of these homebuilder stocks, which shows PulteGroup moving from a low below $6.00 to over $18.00, it becomes clear that investors are aware that the housing market is well off the bottom. The problem is that homebuilder stocks are now relying on similarly large growth rates going forward. The prices for homebuilder stocks reflect perhaps an unrealistic expectation, in my opinion, of what’s possible over the next year or two.

While the Federal Reserve will keep interest rates low for some time, this should be supportive for both new home construction and the mortgage-financing units of homebuilder stocks. But at some point over the next year or two, as the economy improves and the Federal Reserve starts to raise interest rates, we will see homebuilder stocks start to have less revenue from their mortgage-financing divisions as the spread narrows.

As always, the stock market is eight to 12 months ahead of the curve. A year ago, no one was talking about the rebound in the housing market, yet here we are in full swing. As can be seen by chart, the uptrend for this stock has already been broken in November. The question is: is this a pause in the bull case that will later resume, or will we see additional declines going forward?

I think it’s too early to call a top for homebuilder stocks, but they’re not cheap at these levels either. I believe once we start getting hints that the Federal Reserve will start to look at raising interest rates, this will be the point at which homebuilder stocks will start declining significantly. Until that time, homebuilder stocks will ride the rebound in the housing market, as well as revenue growth in their mortgage-financing units.

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About the Author, Browse Sasha's Articles

Sasha Cekerevac, BA Economics with Finance specialization, is a Senior Editor at Lombardi Financial. He worked for CIBC World Markets for several years before moving to a top hedge fund, with assets under management of over $1.0 billion. He has comprehensive knowledge of institutional money flow; how the big funds analyze and execute their trades in the market. With a thorough understanding of both fundamental and technical subjects, Sasha offers a roadmap into how the markets really function and what... Read Full Bio »

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