360 Degrees of Homebuilders

I'm still comfortably ensconced in the first camp. I am hearing about a lot of cancellations. High cancellation rates can effectively nullify any new sales. Builders are now taking a cue from their prospective buyers and walking away from land deals. This is not breaking news -- but it's so rampant and widespread that I don't know how it's possible to accurately discount this into the stock price.

For example, when Standard PacificSPF, a California-based homebuilder, posted results last month, it disclosed that it had written off $16.3 million in deposits and due diligence (preacquisition) costs for abandoned or uncertain projects.

Similarly, HovnanianHOV recently disclosed that it will be walking away from substantial land-option deposits. The company couldn't even quantify the cost in its forecasts.

We are seeing similar expenses incurred by D.R. HortonDHI ($52 million), NVRNVR ($26 million), Pulte HomesPHM ($62 million), CentexCTX ($36 million) and LennarLEN ($22 million).

Now, it would be a mistake to believe that expenses of this kind will continue. They won't, but they'll persist longer than you might imagine. How could that be? With only so many deals in the pipeline, how many more deposits are left to forfeit? Well, lots of these deals are land-development deals and may not be scheduled to close until 2007. Also, homebuilders make money when they sell finished product, so the continual slowing of construction starts equates to decreasing revenue and profit going forward.

In addition, I have a thesis, based on anecdotal evidence, that divisions are not being straight with the corporate offices. In a slowdown of this magnitude, executives become fearful of losing their jobs if they disclose the "real deal." Employment insecurity reigns supreme in this environment and fosters selective disclosure. Sales agents are being instructed to conceal cancellations until they have resold the unit. That's wrong.

Refundable deposits on units that have not yet received a "final report" are being reported as bona fide sales. That's dumb. Acquisition-related marketing reports are being fudged in order to make deals look better, with the hope that the economy will pick up in time. That's suicide.

So let's take a look at a few of the bigger names. Remember, strong stocks can become overbought and remain that way far longer than most folks realize. Conversely, and more to the point, weak stocks can become oversold and remain that way for quite a while, too.

The Philadelphia Housing Index has been treading water since last month, with no real sign of a turnaround. Notice how oversold the relative strength index (RSI) had become, falling well below 30. That doesn't happen often, and is a sign of extreme weakness. But unless the HGX moves back above 210 or so, I'd look at the current weakness as an opportunity to unload some shares. Let's take a look at a few stocks now.

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Beazer Homes BZH took a 50% haircut from the January high, but it doesn't appear as if it was enough. A series of lower highs and higher lows after a sustained downtrend is typically a continuation pattern -- not consolidation. I'd look for more downside if the stock falls below the support line I've drawn above. I would not be surprised to see the stock test $30 before this is through. (Let the hate mail fly).

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D.R. Horton is showing the same type of pattern we saw in Beazer. Notice how long the price-by-volume bar is at the $22 level? A lot of stock has been changing hands here. I'd look for additional supply to push the stock lower. If the price drops below $20, it's probably not a good idea to stick around.

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MDC HoldingsMDC has been trying to find a bottom around $42. RSI is showing extreme weakness. It's not even faking a bounce. I'd be a seller on any move below $42, and if you're looking for a better reference point than this weekly chart, then zoom out to a monthly chart.

This is for those who keep saying, "The homebuilders just can't go down any more." Enough said.

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Want to see a strong homebuilding stock? Go south of the border to Mexico. Desarrolladora HomexHXM is the strongest of the bunch, but seems stalled at $40. I wouldn't be a buyer until this stock breaks through resistance.

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That's my current take on the homebuilding group. If you want to know when these stocks are likely to turn around, I'll let you in on the best "tell" for this industry: It's you! When you start seriously thinking about buying a new house -- or hear your friends talking about it -- then you've got a pretty good idea that you're getting in on the ground floor of a meaningful advance. I just don't see that happening for many, many moons.

Be careful out there.

Little Pink Houses Out of Homebuilders' Reach, by Howard Simons

This column was originally published on RealMoney Aug. 22 at 10:59 a.m. EDT.

Ain't that America, home of the free
Little pink houses for you and me.
-- John Mellencamp

Being an astronaut must be fun, even if NASA manages to lose the home movies of one of humanity's greatest achievements, as it recently disclosed it did with the Apollo 11 moon-landing footage. As a rocketeer, you get to see things from above and in perspective. Of course, you can do the same thing on a much smaller scale from an airplane window.

I used to have to fly to Tulsa, Okla., on a fairly regular basis, giving me a broad perspective of that state's topography. Eastern Oklahoma now has more lakes than Minnesota; and Tulsa, which is on the Arkansas River, is a seaport. Both facts are attributable in large measure to the work of Sen. Robert Kerr, chairman of Kerr-McGee, who served in the Senate between 1949 and 1963 and who was a key player in rounding up the votes for fellow Sen. Lyndon Johnson. As chairman of the Select Committee on National Water Resources, Kerr took payment in dams, as evidenced from a mile-high view of his state. The point: from space, you can see what a U.S. senator is really capable of doing.

Fly into any major city today, and if your memory is long enough, you will see urban sprawl extending much farther than before. The point is: From space, you can see what monetary policy and the Federal Reserve are capable of doing. You can see clearly the results of the grand social experiment of driving interest rates lower between 2001 and 2004, when the first rate hikes began, softly and slowly, to remove the stimulus for credit-dependent industries, such as homebuilding.

Changing Fortunes for Homebuilders

This is exactly how interest rates are supposed to affect the economy. In theory, interest rates equilibrate between future and present consumption. Higher rates discourage present consumption in favor of future consumption, while lower rates do the exact opposite. And markets do move to excess. It was not enough for some that a few marginal homebuyers could now qualify for some plain-vanilla 30-year fixed-rate mortgage; no, we had to jam anyone who could fog a mirror into undocumented option-adjustable-rate mortgages. We shifted a lot of housing-related investment into those years and created a boom for homebuilders.

Oddly enough, the beneficiaries of this boom kept a level head, if the National Association of Homebuilders sentiment survey is to be believed. This index, which recently hit a low of 32, spent most of the time in the period from March 2000 to August 2005 between 55 and 70. During this time, the relative performance of the S&P 500 Homebuilders Index to the S&P 500 as a whole did nothing but rise in a straight line. Incidentally, the last time I addressed homebuilders specifically in this column was in August 2005; the negative action then was attributable to rising mortgage rates.