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Home Prices Pressured, but Builders Surge

Economist Robert Shiller sees more weakness ahead.

There was a barrage of housing data this week that showed home prices are coming under pressure across the country. Nonetheless, homebuilder stocks surged on hopes that the declining U.S. housing market is starting to form a bottom.

Noted Yale economist Robert Shiller, however, believes (as do several hedge fund sources) that the market still has a ways more to go down.

House-price appreciation nationally slowed in the third quarter of this year, and prices in several states actually are dropping, according to the closely watched Office of Federal Housing Enterprise Oversight House Price Index released by the federal government this week.

Nationally, U.S. home prices were 7.7% higher in the third quarter than a year earlier. But from the second to third quarter, prices rose just 0.9%.

Five states -- New York, Rhode Island, Michigan, New Hampshire and Massachusetts -- saw price declines over this sequential period. Michigan, which has been ravaged by layoffs in the automotive sector, became the first state in more than six years to show a year-over-year decline in prices (down 0.6%).

Quarter-to-quarter price declines also occurred in more than half the cities in California.

The hot new housing states across the country are Idaho, Utah and Oregon, which all posted 17% year-over-year house price appreciation in the third quarter.

The new highflying city is Bend, Oregon, a popular retirement destination, which saw a 30% price increase from a year earlier.

While the Ofheo numbers showed housing prices are looking a little weak, the picture painted by the S&P/Case-Shiller Home Price Index looks even worse.

The index, which tracks home prices in 10 major metropolitan cities across the country, shows that as of September, annual gains in home prices are at lows not seen since mid-1997. Prices in September were up 3.7% from a year ago, compared to a peak of 20.5% in mid-2004.

The index shows that San Diego and Boston were the weakest markets, down 1% and 3.3% from a year ago, respectively. Two more regions -- San Francisco and Washington, D.C. -- are very close to showing annual declines in their home price markets. Both regions have shown monthly declines of 0.5% to 1% in each of the last four months.

So what happens to home prices now?

"People who are into risk management would consider the possibility that it might go down substantially; the fact that this could be a historic turning point," Shiller told

in an interview this week.

Shiller, a true housing skeptic who helped develop the Case-Shiller Home Price Index, famously predicted the Internet stock bubble when he published

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Irrational Exuberance

at the height of the boom in March 2000.

He has recently argued that housing prices are following a similar pattern to dot-com stocks.

Home prices simply went up too far and too fast, he says. "Part of what drives these markets is investor excitement. We saw that in the 1990s for the stock market. And we saw it again in the early 2000's for the housing market," Shiller says.

"The concern is that that kind of investor excitement can drive prices higher for a while. But the excitement can't last forever, and that's why there's a risk of a downward correction," he adds. "On the other hand, it's very hard for anyone to say when a speculative boom ends. And they tend to last longer than anyone thought.

"So there is a possibility that we're seeing a downward correction and then it will go up for years more, and then maybe we'll have an even bigger down," Shiller says.

He adds that this could be a historic turning point.

"This would be around the time when prices fall, and they will be weak for years," he says.

Homebuilders Built Up

Any prolonged housing price decline would not be good news for homebuilders. Most public builders continue to say they're cutting prices to move homes since inventories remain near all-time high levels.

Nonetheless, investors seem to be getting more confident on the builder stocks. On Thursday, Bank of America analyst Daniel Oppenheim, a big bear since 2005,

upgraded the sector from cautious to neutral. The sector zoomed on the news, with

Standard Pacific


rising 10% and

Pulte Homes


jumping 9% on the day.

Oppenheim's change of stance comes as builder stocks have jumped an average of 22% since bottoming this summer.

Toll Brothers


is up a whopping 45% to $32 after bottoming in mid-July. The luxury-home builder is still down 7% for the year, however.

Oppenheim's neutral stance on the builder stocks might be the best option of all now, says one hedge fund manager who closely follows the sector. The recent run in the stocks has been helped by the fact that

Federal Reserve

Chairman Ben Bernanke stepped to the sidelines and stopped cutting rates.

As a result, the average rate on a 30-year mortgage hit 6.14% this week, the lowest level since January, according to

Freddie Mac


Nonetheless, the feeling is that the next big home-selling season, which starts in January, is the next catalyst to get the sector moving in either direction. "That's when these stocks will really get to the next level," the manager says.

The philosophy has always been to buy the builders when they're at book value. They're now at 20% to 30% premiums to book value, so "it's hard to get conviction on the stock prices," the manager says.

The issue of housing prices will become very apparent in the selling season from January to May. That's because banks will start turning the screws on the private builders that are having trouble selling homes. Public builders, which use long-term debt, are better capitalized.

Nonetheless, if the private guys face a lot of pressure from their lenders, they could be pressured to aggressively cut prices on homes to move them, which would be bad news for public builders.