Homebuilding Stocks Continue to Plummet. Here’s How to Short Them

Housing is an issue for all of us – as investors, and as ordinary people in need of a roof over our heads.

As investors, there’s always lots of housing news toward the end of the month.

The NAR releases its “pending” and “existing” home sales reports, which include sales volume and prices.  The Commerce Department releases its New Home Sales report.

I like to keep you updated on those reports here.

The news in late October wasn’t good. I have been warning about this for months.

Homebuilding stocks have tanked since I suggested in early October that they were ripe to be shorted. It was an opportunity for big profits.

So should we harvest those profits now?

Here’s what you need to know from the latest housing data…

Ignore Outdated and Seasonally Adjusted Home Sales Data. Pay Attention to These Numbers Instead

The NAR released its existing home sales data on October 19.

It’s essentially useless data because it tells us merely how many homes that were sold in previous months went to closing in September. Closing is a rubber stamp formality in 90-95% of sales. Furthermore, it’s old data. The September “sales” were already typically 6-8 weeks beyond the contract date. So the October 19 report covers sales made mostly in August.

The real sale is the signing of the sales contract. The NAR calls that data “pending” home sales. But it’s the only data that matters, because it’s when all parties to the sale, including the realtor, buyer, seller, and other buyers in the market, consider the property sold. The SOLD sign goes up and the house is listed as SOLD in the MLS. It’s when the price is set.

So that’s what we pay attention to. The NAR reports it. They call it “pending home sales.”

The pending home sales report for contracts signed in September was released on October 25. For real estate, a one month delay is quick enough. Until it isn’t. And right now we’re getting to the threshold of one of those “until it isn’t moments.”

Take October 2005. Sales were rocking that summer. And then they simply dried up. Sale prices remained astronomical, but there were few sales. Any seller who found a buyer was essentially a lottery winner after October 2005. The market had dried up.

Now we know that housing sales have been softening recently. I’ve been reporting it here for the past few months. Even the media has recognized it. But here’s what’s funny. Today, they’re reporting, Whoop de doo! Sales were up in September! All major media outlets dutifully reported a 0.5% increase in the seasonally adjusted number.

But you and I are not consumers of the seasonally adjusted hocus pocus. We like to know what really happened. So we look at the actual, unmanipulated sales numbers.  We compare them on the basis of monthly and year to year change. That tells us what’s really going on, and it’s even easier to see on a chart.

Home Sales Fell 20.3%. That Makes This the Worst September Since 2014

So did sales actually rise in September?

Well, no. They didn’t. The reported increase was an artifact of the seasonal manipulation factor. On a month to month actual basis, sales fell 20.3%.

Sales are always down in September of course, so to judge the degree of weakness, we compare this September with years past. Lo and behold, this was the worst September performance since 2014. Last year, in 2017, September sales only declined 16%.

Furthermore, year to year sales momentum was worse too. This month saw a 3.4% decline versus September 2017. In August the annual rate of change was only minus 2.6%, and in July it was just -0.7%. So there was no uptick in this comparison either. The trend of sales is weakening.

The chart speaks a thousand words.

The weakening began in 2016. Not coincidentally, that’s when Fed subsidized mortgage rates reached their lows. In September 2016, the 30 year fixed mortgage rate was 3.6%. Today it’s approaching 4.9%.

The chart also shows the price trend, reported by the NAR in the existing home sales release. Price inflation looks relatively stable visually, but in fact it has slowed from +5.9% in January to +4.2% in September.

That’s still faster than the weekly employee earnings inflation, which has been averaging 3% in recent months. Housing affordability is still worsening.

Mortgage rates got a brief reprieve when the stock market sold off in October. But they’re on the way back up. Rates are tied to the yield on the 10 year Treasury, which peaked in recent weeks at 3.25%. It pulled back to 3.12 but is now back to 3.22. Keep an eye on that 3.25 level. If the 10 year yield clears 3.25%, then the 30 year mortgage rate is likely to blow through 5% and keep going.

That could be the death knell for housing demand like the one that rang out in 2005 and 2006 as the great housing bubble topped out. It took prices another year to start dropping. In housing, volume precedes price. Sellers are slow to respond to weakening demand as they hold out for yesterday’s prices.

Shorting This Homebuilders ETF Worked Before. Let’s Do It Again

A few weeks ago, I recommended shorting ITB, a homebuilders ETF.

In that report I worried that there would be no rebound for executing a lower risk short sale position. So I recommended shorting a half position immediately, while holding out for a rally to short the remainder.

Since that report was published on October 4, the ITB was down as much as 13%.  With the required 50% margin for a short sale, that would have been a profit of 26%. It has since bounced back to 32.50. That’s a key level for trading purposes. I would put a mental buy stop at 32.60. But if it rolls over I would add the other half short position if the price hits 31.40.

Sincerely,

Lee Adler

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