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Position: We are bearish on housing as we get closer to 2Q10 and short TOL. 

 

Stories like the one in the WSJ yesterday are scary and a reminder that most home builders don’t have a macro process and seemly ignore reality.

From the WSJ - “Spec houses rise as builders bet on buyers before tax credit ends - home builders are ramping up speculative construction to attract last-minute home buyers who want to tap a soon-to-expire tax credit.”

From a MACRO perspective the housing market is going to face headwinds for years, despite the fact that supply of homes have come down during the recession.  We don’t need more new homes and the ones being built should not be done on speculation. 

The MACRO headwinds include:

(1)    Slowing household formation - slowest level in 15 years

HOUSING - SECULAR HEADWINDS - hp1

(2)    Rising interest rates - Conventional mortgage rates are at 5% right now - right around their all-time low. If rates were to back-up to 6%, a 100 bp move, this would lead to a 10.5% decline in affordability for borrowers, which equates to a comparable drop in home prices.

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(3)    The potential number of foreclosed homes is high and rising -

HOUSING - SECULAR HEADWINDS - hp3

I understand that if you are in the business of selling homes you can’t make money if you are not selling any.  Taking increased risk in this environment only seems to be a losing strategy.  Some of the small builders seem to suggest that “builders lost sales because they didn't have enough houses to satisfy a flurry of demand from buyers looking to take advantage of a federal tax credit for first-time buyers before they expired on Nov. 30.”

The seasonal pattern of home sales suggests that those buying homes will wait until the last few months of the new program in March and April.  The current credit, which offers first-time buyers up to $8,000 and repeat purchasers up to $6,500, applies only to deals signed by April 30 and closed by June 30, 2010.

Fortunately, Pulte Homes Inc and KB Home have a different view of building spec homes in the current environment.  Not surprisingly, the biggest builders got caught with a lot of inventory just as the current downturn started. 

Our bearish stance on housing is expressed by being short TOL.

HOUSING - SECULAR HEADWINDS - hp4

Howard Penney

Managing Director