Energy Gives Housing an Inadvertent Boost

Homebuilding shares rallied yesterday thanks to a positive note from Salomon Smith Barney, which encouraged investors to "use the recent pullback in the stocks as a buying opportunity."

Based on the group's improved return on capital in recent years, Salomon analyst Stephen Kim argued that the

traditional peak for homebuilders of two times book value should no longer apply.

"We reiterate our opinion that price/book ratios are rapidly losing their relevance as a valuation tool for this group," he wrote, suggesting homebuilders ultimately should trade at forward price-to-earnings multiples in the 12-15 range vs. 7-9 today.

In a negative overall market, the S&P Homebuilding Index was up 0.7% at midday. The group was buoyed by the ongoing fallout from Kim's call and from a general feeling that higher oil prices will help the group because they will keep the

Federal Reserve

from tightening.

Among individual names,

Ryland Group

(RYL)

and

Toll Brothers

(TOL) - Get Report

had traded at new 52-week highs intraday today.

Homebuilders had struggled prior to their recent rally -- the Homebuilding Index was down more than 9% since early March heading into today's session -- falling as bond yields rose on fears the Fed would tighten as early as its May 7 meeting.

But as those fears receded, so have yields on the benchmark 10-year Treasury and mortgage rates along with them. For the week ended April 4, the average 30-year fixed mortgage fell to 7.13% from 7.18%, according to

Freddie Mac

(FRE)

.

So it's not surprising that homebuilding stocks have regained momentum as the rise in mortgage rates subsided.

(For those curious, Seabreeze Partners'

Doug Kass commented on

RealMoneyPro.com

this afternoon that he would "wait to reload on the shorts for now," although he remains short Toll Brothers,

Centex

(CTX)

and

Pulte Homes

(PHM) - Get Report

.)

Although homebuilders have risen in the short term, it is dangerous to be optimistic about rising energy prices because of their impact on consumer pocketbooks and the economy in general.

The Trouble With Oil

"Higher energy quotes menace growth and threaten to hike inflation expectations," Richard Berner, U.S. economist at Morgan Stanley commented yesterday. Even President Bush acknowledged rising oil prices could restrain the economy's recovery, as

The Wall Street Journal

reported.

Berner forecast $24-per-barrel oil by 2003 in his recovery call early this year and admitted the recent jump in prices occurred "far more quickly than we expected."

The economist believes the Fed won't raise rates until August at the earliest because of the "increased geopolitical risk and slower spring growth," in part because of rising energy costs.

Still, he forecast 10-year Treasury yields will approach 5.75% in the coming months. That will almost surely result in an accompanying climb in mortgage rates, which remain a key element to homebuilders' success.

Remember, Berner is the optimistic one at Morgan Stanley. Global economist Stephen "

Double-Dip" Roach forecast today that rising oil prices could subtract as much as 0.8% from global GDP growth this year and 1.3% in 2003, while adding as much as 1% to global CPI in 2002 and 0.75% in 2003.

Admittedly, that's in a worst-case scenario of a "permanent spike" to $40 per barrel of oil, which Roach isn't forecasting -- he's just modeling for the possibility, as well as for less onerous scenarios.

"Shocks always seem to have an uncanny knack of exposing the problems that are already festering," Roach wrote. "Another oil shock would be little different in that critical respect -- it could deal a lethal blow to a nascent and still fragile global recovery."

The same could be said of the nascent U.S. recovery, which brings us back to the homebuilders. Yes, the industry is less sensitive to economic cycles than in the past, and housing's strength helped mitigate the downturn last year. But those cheering the rise in oil prices would have investors believe that homebuilders are immune to the economy's machinations. It's the quintessential "it's different this time" argument.

Furthermore, "homes are only as sound as their foundations,"

The Economist

recently said, a reference to the stretched balance sheets of many U.S. homeowners. Homeowners may no longer have the opportunity to borrow at extraordinarily low rates and possibly face another rise in unemployment, as the March jobs data indicated.

Finally, that homebuilders were higher today as oil prices retreated -- after Saudi Arabia said it won't join Iraq's production halt -- suggests that the link between the group and energy prices is tenuous. Those propagating views to the contrary are foolhardy at best and duplicitous at worst.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.