Headline: Housing is due for a crumble under weight of economy

Source: Scott Herhold, San Jose Mercury News, 30 August 2001

URL: http://www0.mercurycenter.com/premium/business/docs/herhold30.htm

In the bad old sexist days of Wall Street, traders used to have a saying: ``When they come to raid the house, they take all the girls.'' By that they meant that when a downturn hit, it eventually hit everyone.

In a more enlightened age, we can condemn the language. But the thought retains its force: Anyone who has been in the tech market over the last year knows that even the supposedly sheltered stocks -- storage, say -- got hammered.

I mention this because one big sector of the American economy has yet to feel the real pain of our economic slowing: housing. While they've slipped a little recently, the stocks of America's home builders are still about 80 percent above where they were two years ago.

Now much of this is deserved: Buoyed by mortgage rates that hover near 7 percent, American home buyers have stubbornly ignored a pending recession.

Late last week, the U.S. Commerce Department reported that the sales of new homes were up by a surprising 4.9 percent over the same period last year. And the number of used homes sold -- more than 5 million -- is still more than twice as much as it was. But it's precisely for those reasons that I think housing is due for a fall -- and the stocks potentially worth shorting (that is, betting on their decline). Although the stocks look cheap compared with tech -- their looking-back price-earnings ratios are generally about 19 or 20, compared with 29 for the S&P computer system index -- they're vulnerable because they can't defy gravity forever.

Begin with the bedrock of the housing market: jobs. ``The underlying demand for the housing market is job growth,'' says John Burns, a vice president for the Meyers Group, an industry research group. ``That's what attracts people to move to an area. It's what allows Johnny to leave home.''

In case you missed it, America's job growth is somewhat worse than anemic. As I write this, Gateway has just announced that it will lay off 5,000 people, one-fourth of its workforce. But it hardly counts as news anymore. It's simply another bedraggled entrant in a parade of woe.

Now Burns, for one, points out that the affordability of houses, particularly in places such as Las Vegas or Phoenix, has made for a robust market. But people out of work aren't interested in buying any houses. Some of that was evident in the news this week. The National Association of Realtors reported that existing-home sales had slipped by 3 percent in July, from 5.33 million units to 5.17 million. That was its slowest pace in six months.

``Given the huge volume of home sales over the last five years, we're still seeing very strong demand but the pressure is starting to ease,'' said David Lereah, the association's chief economist.

This should sound familiar to tech investors -- as in Cisco Systems Chief Executive John Chambers' famous statement in January that the quarter was going to be a ``little more challenging.'' A downturn usually starts with a whimper, not a bang.

Look more closely at the SEC filings and recent announcements of some of the nation's biggest home builders -- Lennar (LEN), Pulte (PHM), Toll Brothers (TOL), Centex (CTX) or DR Horton (DHI) -- and you'll see more warning signals. The number of orders received for new homes by Denver-based MDC Holdings, for example, fell from 779 in July 2000 to 602 in July 2001. At the end of June, Pulte had $2.3 billion of inventory available -- that is, unsold homes -- compared with $1.8 billion at the end of 2000.

What's more, there's been a clutch of insider selling at a number of these home builders. At Pulte, for example, more than a dozen former executives at Dell Webb homes, which Pulte recently acquired, have sold positions in the past six weeks. At MDC, five insiders have sold more than 1 million shares since May.

All this reflects what anyone in the Silicon Valley housing market knows intimately. There aren't as many buyers. And there are more sellers. And inevitably, the balance tips toward lower prices.

So what's an investor to do? Well, one possibility is to consider shorting three or four of the major home builders. This was a strategy suggested a couple of weeks ago in Barron's by Doug Kass, a hedge-fund manager with Seabreeze Partners. (Remember, in a short, an investor borrows the stock, sells it immediately, and bets that the price declines. If it does, the investor buys it back at a cheaper price, returns the shares to the lender, and pockets the difference.)

But even if you don't short these stocks, you ought not to think of them as safe havens. Even blue-chip stocks such as Home Depot, which have been trading up and down this year, aren't particularly safe. People do their most expensive remodeling after they buy. And when they're worried, they put off adding the extra bedroom.

-- Andre Weltman (aweltman@state.pa.us), August 30, 2001

Answers

This is a fascinatng piece, offering good insight. But, as far as Home Depot goes, I would think that they would benefit, because delayed purchases of newer housing should lead to the purchases of more fix-up and repair stuff. I remember reading that this was the case during the Great Depression of the 1930s.

-- Loner (loner@bigfoot.com), August 30, 2001.

I would agree with the fact that Home Depot and Lowes would do well in a downturn market for homes. However...it would be interesting to know how much of their business is from building contractors and how much from do it yourselfers. We have a contractor friend who does only remodeling as he has gotten a bit older. Until recently, he had at least a 6 month waiting list to get him to do some work. Now HE is waiting. He is staying busy but says its one week to the next on bookings. So if contractors are getting their stuff from Lowes and HD then they too are going to feel the pinch. Taz

-- Taz (Taz@outintheforest.com), August 30, 2001.