Inspecting Housing's Foundation for Flaws

Sales of new homes fell 6% in July from June to an annual rate of 1.13 million, the slowest pace since December. That was almost 2% below July 2003, as well. The number of unsold homes on the market has been building as inventory stood at 393,000 at the end of July, a 15% jump from a year earlier.

Existing-home sales hit a record annual rate of 6.9 million in June and then fell off almost 3% in July to 6.7 million. Economists are forecasting a further slowing of sales to 6.6 million for August.

The Mortgage Bankers Association index of applications for purchases dropped 4.3% for the week ended Sept. 10. It's still 11% higher than a year ago. The rate on 30-year mortgages of 5.68% for the week was 0.3 percentage points lower than a year ago.

Of course, not everyone is ready to write off the housing boom just yet. (Notably, several RealMoney.com contributors have expressed optimism about homebuilders of late, including Jim Cramer, Dan Fitzpatrick and Steve Smith.)

"Following record levels of new single-family home sales in May-June and the sustained low mortgage rates, we expect housing activity and new housing starts to remain firm in coming months," Bank of America economist Mickey Levy recently opined.

In an interview on CNBC Wednesday evening, Pulte Home (PHM Quote) president and CEO Richard Dugas said: "People look at [moderating] overall housing stats, but we're in a position where we're taking share. The large builders are in great shape."

Homebuilding stocks have certainly been in great shape, up more than 11% since Dec. 31 and over 40% in the past year. Still, a couple of the bigger players cooled in the past week, including Pulte and Lennar (LEN Quote).

Supply/Demand Imbalance

Housing's many skeptics say the rapid pace of sales has obscured the magnitude of inventory overhanging the market. Another 2.4 million houses were on the market at the end of July, according to the National Association of Realtors. That represented only 4.3 months supply at July's rate of sales -- but if sales slowed even to 2001 levels of about 441,000 a month, the inventory ratio would jump to 5.4 months.

A Morgan Stanley research report last week pointed out that the inventory situation is even worse than it appears in the months-of-sales ratios. In absolute terms, inventories have risen for almost five years and, as a proportion of total homes, are reaching the 1990s recession level of 2.5%.

Rapid turnover -- the quick flipping of homes to cash out huge price increases -- is masking the inventory buildup. Turnover is at an all-time high of tover 9%, Morgan Stanley's analysts wrote.