Last week, a report from the National Association of Realtors said, "The housing boom has ended but sales will continue at historically healthy levels with price appreciation returning to normal patterns across much of the country."
The group is not alone in its sanguine assessment of current conditions. Over the past few months, I have heard the words "mild," "moderate" and "cooling" when describing the slowdown in housing prices. However, 12 months from now, this optimism could turn to wishful thinking as higher interest rates cripple this erstwhile pillar of the economy.
But the fallout is going to hit more than homeowner equity. Here are three stocks that this downturn will hurt the most, and should be sold on strength: Countrywide Financial
(CFC:NYSE)
, Lowe's Companies
(LOW:NYSE)
and Target
(TGT:NYSE)
.
First, let's examine the increased costs of home ownership. Over the past five years, the median home price in the U.S. increased more than 11% annually as of year-end 2005, including a 13.6% rise last year, according to the Office of Federal Housing Enterprise Oversight (OFHEO). In San Francisco, the average price for a home is $718,000 and in the New York metro area, the average price is $472,000.
To put this into perspective, I used a mortgage calculator and entered data including the average home price, the mortgage rate and a 20% down payment to compare today's averages with the averages from three years ago.
In 2003, the average home price in the New York metro area was about $320,000, according to the National Association of Realtors, and the average 30-year fixed rate mortgage loan was 5.6%. With a 20% down payment, or the amount needed to avoid paying personal mortgage insurance (PMI), the monthly payment was $1,470.
Today, using the same calculator, but with today's average home price in the New York metro area ($472,000), the current 30-year fixed rate (6.6%) and 20% down, the monthly payment jumps about $1,000 to $2,410.
Keep in mind that these figures do not include taxes, which could add at least $400 a month to the payment, oil prices (which are 100% higher than they were in 2003), electricity, heat, water or home insurance. This could easily add $800 to the payments; when you add the other monthly expenses such as cable, car insurance and food to that, it could total $4,000.
That's roughly $50,000 a year, after taxes, just to own a home in today's marketplace and pay other living costs -- with $94,400 used as a down payment (20% of $472,000).
So who does this hurt? Mortgage lenders, home improvement stores and retailers.
Put Countrywide to the Side
Because of the higher mortgage rates, I believe fewer homes will be purchased over the next 12-18 months. This could have a major impact on Countrywide Financial, which derives 50% of its profits from mortgage banking and is considered the largest U.S. independent residential mortgage lending firm.
Countrywide does hedge against inflationary risk, but this just makes it a best-of-breed stock in a declining industry. This is no reason to own the shares here, and I'd sell them now because higher interest rates will reduce mortgage activity, resulting in lower home prices and eventually lower profits.
Looking Down on Lowe's
Lowe's is another stock that could feel some pressure. The second-largest home improvement center in the U.S. is a one-stop shopping place for new homebuyers and homebuilders. Despite the largest homebuilders calling for a slowdown in the national and local housing market and losing anywhere from one-third to one-half of their market value, shares of Lowe's are up 5% this year.
A slowdown in the real estate market will lead to fewer home improvements. After reviewing Lowe's first-quarter results announced on May 22, the trend may have begun, with management slightly lowering its guidance for the second quarter. There could be downward revisions within the next three to six months from sell-side analysts as this trend persists, and shares should be sold here.
I considered adding Home Depot
(HD:NYSE)
to my list, but its share price is down about 18% over the past three months due to a large acquisition, and rising shareholder frustrations.
Lastly, shares of Target could also come under some pressure over the next year.
Target missed margin estimates in its first quarter reported on May 15. The company announced that one of its largest-margin and worst-performing segments for the quarter was home furnishings and decoration.
Target, unlike Wal-Mart
(WMT:NYSE)
, has no international exposure. This means it's 100% levered to the U.S., and a slowdown in the housing environment and the economy do not bode well for the company.
I would use the bounce provided by the recent upgrade from Lazard Capital as an opportunity to sell.
In keeping with TSC's editorial policy, Frank Curzio doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Frank X. Curzio is a research associate at TheStreet.com, where he works closely with Jim Cramer. Previously, he was the editor of The FXC Newsletter and senior research analyst for Greentree Financial. He appreciates your feedback; click here to send him an email.
