12/04/2007
US housing market tea leaves difficult to read as decline to continue
Shareholders of US homebuilders could be forgiven for a recent bout of travel sickness: since the start of the year the stocks have been particularly unstable in what is a notoriously volatile sector. After signs of recovery in January, with shares rising 7%, the crucial spring selling season has proved to be a disappointment even before the full effect of the sub prime mortgage tightening has taken hold. The stocks have reacted accordingly and are down some 25% from February highs as expectations have been reset by a constant flow of negative news. These fluctuations vividly illustrate some of the challenges the market faces in interpreting news flow on the state of the US housing market.
At the very least, official data should be treated with a healthy scepticism. Problems with seasonal adjustment and small sample sizes can render monthly data misleading and the accurate calculation of sales volumes and inventories is difficult. Broadly speaking, however, the numbers can still tell us something. For example, house price data released by S&P Case-Shiller clearly illustrates the local nature of the US housing market and the changing economy with Seattle, home of Starbucks, enjoying growth (up 11% in the last year) even as auto capital Detroit’s decline continues (down 7%).
The inherent bias of most commentators, many of whom have a vested interest in keeping sentiment positive, is also an issue. It not only contributes to the boom but prolongs the bust as sellers are slow to adjust their expectations downwards and existing home inventory stays on the market for longer. For example, regular visitors to the National Association of Realtors’ website have been assured that the bottom is near for the best part of a year. Perhaps one sign that the real estate industry is finally making much-needed changes is the recent demise of the infamous condoflip.com (tagline: “Bubbles Are For Bathtubs”).
Many observers and industry executives claim that underlying demand for new homes in the US is around 1.8 to 2 million houses a year, a run-rate which, since 1987, has only been achieved in the period 2003 to 2006. Yet these same individuals will also note that much of the demand of the last three years was driven by speculators, thus implicitly conceding the vaunted 2 million homes a year figure is probably rather optimistic.
Happily for contrarians, the rhetoric has started to change: in early March the chief executive of DR Horton, the nation’s largest homebuilder, delivered what could prove to be one of the sound bites of the cycle: “2007 is going to suck, all twelve months of it.”
With these informational challenges in mind, what of the future? As the spring passes, sellers of existing homes are likely to lower their sale-price expectations as time runs out for those who need to move before the back-to-school deadline in the autumn. Coupled with a further reduction in demand as lending criteria tighten, there will be continued house price pressure in most markets, further margin contraction at the public builders and an ongoing reluctance by would-be buyers to close on purchases until they believe that prices have stopped falling. Arguably, much of this is already priced into the stocks of the public builders, but that, of course, is little comfort to those on the wrong side of the downturn.
Bull points
Buyers still exist at the right price
Unemployment is low
Builders are more realistic
Bear points
Inventory is likely to rise further
Prices will continue to decline
The sub prime shakeout will delay a recovery
Stephen Clark, Fund Manager, Standard Life Investments Global Advantage Fund (US), Standard Life Investments
First published in Investment Week 12 Apr 2007
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