As we continue flirting with a final top in equities for the year, I am stepping up my search for the best ways to participate on the downside. At the very top of the list are the homebuilders, one of the top performing sectors since the October, 2011 bottom. The performance of individual names has been absolutely blistering, with Pulte Homes (PHM) clocking a 245% move to the upside, beating the (SPX) by 210%.
You do not need to engage in any sophisticated financial analysis to see how expensive this group is. Spend a day visiting open houses put on by the big companies, like Pulte Homes (PHM), KB Homes (KBH), Ryland Group (RYL), Toll Brothers (TOL), and Lennar (LEN), as I did yesterday. Then scan the real estate pages of your hometown newspaper with a calculator in hand. You will quickly find that new homes are selling for double the cost of existing homes on a dollar per square foot basis.
This is a lot to pay for that black granite kitchen counter, built in vacuum system, flashy gas barbeque in the back yard, and solar panels on the roof. You may also notice that the homes are shoehorned so tightly on to their plots that you will become too familiar with the intimate details of the lives of your prospective neighbors. In fact, new homes are trading at the biggest premium over used in history.
I am loathe to bet against those lucky ones selling to the 1%, or anyone who earns close to them, whose wealth and spending power are expanding exponentially as I write this. That knocks out Lennar (LEN) and Toll Brothers (TOL). I am very happy to short stocks of companies saddled with selling on an increasingly impoverished 99%.
That trains my sites over to Pulte Homes (PHM) and KB Homes (KBH), the old Kaufman & Broad. (KBH) has already fallen 38% off of a poor earnings report. At least Eli Broad had the decency to give away most of his money after selling out at the market top. The Los Angeles art world is all the richer for it. That leaves Pulte (PHM) as the next overripe piece of fruit to fall.
I know that many of you have been getting calls from real estate brokers insisting that the bottom is in and prices are on their way up. I get the same calls from stock brokers too. Here are the reasons for you to let those calls go straight to voicemail.
There is still a huge demographic headwind, as 80 million baby boomers
try to sell houses to 65 million Gen Xer’s, who earn half as much money. Don’t plan on selling your home to your kids, especially if they are still living rent free in the basement. There are six million homes currently late on their payments, in default, or in foreclosure, and an additional shadow inventory of 15 million units. Access to credit is still severely impaired to everyone, except, you guessed it, the 1%.
Fannie Mae and Freddie Mac, which supply 95% of all the home mortgages in the US, are still in receivership, and are in desperate need of $100 billion in new capital each. Good luck getting that out of Washington, which is likely to be gridlocked for at least another five years, and maybe more.
The home mortgage deduction is a big target in any revamp of the tax system, which would immediately yield $250 billion in new revenues for the government. How do you think that will impact home process?
There are undeniable signs of life in best prime markets, where the pent up demand can be substantial. Here in the San Francisco Bay area you are seeing bidding wars for anything that is commuting distance from Apple, Google, and Facebook, or the rest of the booming tech world. Real estate is more local now than it ever has been.
The best case scenario for home prices is that we continue bumping along a bottom for as long as ten more years, when the demographic picture shifts from a huge headwind to a major tailwind. The worst case is that this is just another bear market rally and that we have another 20% on the downside.
Show me the Rally
Yes, But Does It Have Solar?