Why the Housing Market Is Promising but Overextended

Housing MarketThe housing market has clearly bottomed out and is gaining some traction. We are seeing growth in building permits, housing starts, and an upward move in home prices across the nation. The S&P/Case-Shiller Home Price Index, comprised of the 20 largest U.S. metropolitan cities, increased a better-than-expected two percent in August, representing the seventh straight up month. The developer of the index, Robert Shiller, said in a CNBC interview that “there are a lot of positive signs” in the housing market, but he also expressed some caution. (Drew Sandholm. “Shiller: Housing Recovery Could Take 50 Years,” Yahoo! Finance from CNBC, November 1, 2012.)

Yet the reality is that the housing market is on the mend. Wherever you live, the housing market is displaying better industry metrics that help to validate the recovery in the housing market. Speculators should also look at China’s housing market, which I discussed in “Why You Need to Think Long-term with Chinese Real Estate Stocks.”

We recently saw a blow-out report in housing starts and building permits.

In September, there were an impressive 872,000 starts, 13.5% above the 765,000 Briefing.com estimate and its upwardly revised 758,000 estimate in August. Also lending support to the housing market recovery was an equally strong building permits reading at a whopping 894,000 in September, well above the 815,000 Briefing.com estimate and the revised 801,000 estimate in August. The readings were a big surprise and, in my view, indicate builders are expecting a good flow of buying in the housing market. Of course, we need to see how the upcoming October readings fare.

One thing is for certain. The strengthening in the housing market is showing up in the results of numerous homebuilder stocks.

The technical analysis chart of the S&P Homebuilders Select Industry Index (NYSE/XHB) shows the upward trend from the October 2011 bottom to the current high. The upward break at the $22.00 level was bullish, due to the topping action that was evident.

SPDR S&P Homebuilders Index Chart

Chart courtesy of www.StockCharts.com

Homebuilders are continuing to deliver better results. Toll Brothers Inc. (NYSE/TOLL) blew away the Thomson Financial consensus earnings estimates in its fiscal third quarter after reporting $0.36 per diluted share, double the estimate of $0.18 per diluted share.

Revenues at Toll surged 40.6% year-over-year. The backlog of homes surged to 2,559 units, up 44% year-over-year. (Source: “Toll Brothers Reports FY 2012 3rd QTR and 9 Month Results,” Globe Newswire August 22, 2012, last accessed October 18, 2012.)

In the case of Toll, much of the easy money has been made for now. The hefty valuation given to Toll at 30.8X fiscal year 2013 earnings per share (EPS) and a price/earnings-to-growth (PEG) ratio of 3.1 supports this. The stock has moved down from its high of $37.08 on September 21. The key is to buy on weakness.

Moreover, there are still some concerns about the housing market, but I expect housing to continue to improve especially if the jobs market improves. The ADP Employment Report, revised to better reflect the U.S. jobs market as a more accurate indicator of the nonfarm payrolls reading, showed the creation of 158,000 jobs in October, which was above Briefing.com’s estimate of 143,000. The September reading was cut in half to 88,200 jobs from 162,000 based on the new methodology.

At this juncture, housing is looking brighter. If you hold some of the hot homebuilder stocks, I advise taking some money off the table after the run-up in the housing market stocks.