NEW YORK (TheStreet) -- Jeffrey Gundlach, CEO and CIO of DoubleLine on Monday presented compelling reasons to short homebuilders as he offered a bleak picture of home ownership.
Speaking at the 19th Annual Sohn Investment Conference produced in partnership with Bloomberg LINK, Gundlach said a lot of people think that the U.S. home ownership rate is going to rebound. However, he said he's able to make the case that this is not going to happen after digging deeply into the health of the U.S. credit market, the supporting factors behind the housing market, affordability trends, and Americans' wages and income. "My theme today is frankly I believe that single-family housing is over-believed and overrated over the long-term ... I believe this is going to new lows."
In light of this, Gundlach suggested shorting the XHB. "The homebuilder ETF (SPDR S&P Homebuilders) (XHB) has gone up an awful lot. It seems to be potentially rolling over. It looks particularly bad when you compare it to something that it should be highly correlated to, which is lumber. The homebuilding index sitting out there is looking a little bit like it's in trouble, sort of like Wile E. Coyote, who's off the cliff but hasn't begun to fall." The SPDR S&P Homebuilders ETF settled down more than 1% on Monday.
His first point in his presentation focused on the "false" belief that the home-buying public and the American consumer somehow deleveraged and is now in a good position to start borrowing again. He said that, combined, private credit and government credit currently total some $60 trillion in the U.S., an all-time high, or about four times GDP. Private credit has fallen slightly, but only because of mortgage credit being written off through defaults. "This is not exactly the type of declining credit that is healthy and does not bode well for credit increasing in the future as these borrowers are locked out of the market."
His second point focused on housing market supports. He said that the housing market has been supported by a resurgence in second-lien borrowing, and that resurgence is now worryingly back at the same levels seen in the bubble years of 2005 and 2006.
The housing market, particularly existing home sales, has also been supported by a great volume of cash transactions. Over 50% of single-family homes in the last few years have been purchased by investor pools and other cash buyers. "This is not exactly indicative of the organic growth in the market from real buyers," he said.
While there has been a drop-off in cash transactions recently, they remain at very high levels and that has been correlated with a huge decline in the Bloomberg Housing Surprise Index since last summer. "We see that sales have sort of crashed in the last few months," said Gundlach. "When looking at it year over year, we seem to be on the cusp of something of a change happening here, with the existing home sales now negative."
With all the hype about the housing market, new home sales have been "remarkably" flat on their back like they were at the depths of the recession and falling anew once again. "Mortgage purchases, which is the real buying of houses, basically never gained any traction and are at the same levels that they were in 2010," he added.
Housing starts bumped up a bit, but are plateauing. Gundlach said starts are still residing below 1 million on an annualized basis.
Gundlach focused the next portion of his presentation on what he deems to be inaccurate comparisons on housing affordability. He notes that bullish housing market proponents have been referencing charts that they say show that affordability today remains well above affordability in the early 2000s and well above the levels of the housing boom and credit bubble. The inferences are based on the assumption that a 30-year amortizing, conventional type of mortgage is being applicable throughout, when they were in fact not commonly applied in 2005 and 2006, especially in 2006 when 70%-plus of all mortgages utilized in the more credit inflated places like California were exotic types of financing. "The problem with this chart is it doesn't really represent what's going on with the financing markets," he said.
"If affordability was so great, why was the interest rate rise of last year so responsible for such a huge drop off in sales," Gundlachasked. "If you believe [the Fed relaxing its quantitative easing program] that was responsible for the rate rise and therefore rate rises are assuredly coming again, you're looking at a rather bleak picture of affordability." When rates crept up to 4.5% last summer, a $1,000 monthly payment with a 25% down payment could buy a $247,000 home. That's down from about a year ago, when the 3.25% mortgage rates could allow for the purchase of a $287,000 house. If rates shoot up to 6% as many believe they will, the value of the home that could be bought would be reduced to a third of recent levels without even factoring in the magnitude of price increases that occurred with the strong housing market of the last couple of years.
Gundlach isn't convinced that rates could increase to 6%, but he cautions that there will be a spike in rates if Fannie Mae and Freddie Mac, representing a huge fraction of the mortgages that are being created, were wound down by politicians and private money were brought back in. In such a scenario, mortgage rates would go up by 50 to 75, to 100 basis points. "That would certainly impact affordability in a negative way," he noted.
The famous investor rounded out his presentation by pointing out that home ownership rates will likely continue to sink because 70% of the population has been experiencing "substantially" declining wages and income. "It's hard to believe that there can be home ownership of 60%, 65%, to 70% with this kind of statistic ... I'm going to make the bold statement that for the rest of my career we will never see a year of 1.5 million housing starts again."
-- Written by Andrea Tse in New York
>Contact by Email