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“Some men see things as they are and say why.  I dream things that never were and say why not.”

-Robert F. Kennedy

Keith is out this morning, so I’ve been handed the pen on the Early Look.  I will start with this simple admission: getting up every morning and writing an investment strategy note every morning is not an easy thing to do.  Now you know.

Luckily, our Financials Sector Head Josh Steiner is providing ample and interesting fodder for me this morning.  He and his team are hosting a call this morning on the U.S. housing market at 11am eastern.  The title of the call is, “Housing Double Dip: A Game Changer for Financials.”  And the title basically says it all.

Suffice it to say, despite many investors “seeing housing data points as they are”, Josh and his team see the housing market “as it never was.”   In this context, “never was” means a potentially serious double dip.  If you are a qualified institutional prospect and would like to dial in to the call, please email us at .

We have started to see data points that reflect a slowing of the domestic housing market.  In fact, on Wednesday, new home sales collapsed coming in at 300K, which was down 40% month-over-month.  In terms of context, this was the worst new home sales number since 1963, which was when record keeping began.  So, this was the worst number . . . ever.  And ever, as they say, is a long time.

The housing bulls, or even those that don’t buy into the double dip call, rightfully note that this recent data has turned negative in conjunction with the expiration of tax credits.  And, ostensibly, they are correct. This expiration likely does account for the extreme negativity of the these recent data points, but let’s also keep in mind that mortgage rates, so affordability from a financing perspective, remains at near all time lows, which one would expect to continue to encourage purchasing.

In the Chart of the Day below we’ve highlighted MBA Mortgage Purchase Index Applications Indexed to 100 from the start of 2010.  For the past four weeks, mortgage applications have been down -33%, -28%, -29%, and -30% week-over-week sequentially.  Mortgage applications are, obviously, leading indicators for housing purchases.  These applications are clearly indicating it is going to be, at the very least, a long hard summer for home sales.

Without stealing his thunder, and the thunder of the 100+ page presentation he and his team have put together, I think it’s fair to say Josh’s view will be much more draconian than just a tough summer for housing.  Three key points that will be highlighted in the presentation and conference call are:

1)      Housing supply is near record highs and demand has fallen to levels of the mid-90s, which will have a direct and negative impact on housing prices given the high correlation between demand and future pricing with an r-squared of 0.80.

2)      Economics are interconnected, and the decrease in demand is being driven by tight lending standards and an abysmal employment market that shows underemployment at more than 16% currently.

3)      Supply of housing is in the top two deciles of inventory levels, and historically prices have typically fallen more than 15% over the following 15 months when at these levels.  The correlation on an r-squared basis of supply and future pricing is 0.83.

The points above are negative in and of themselves, but there is also a macro elephant in the room in the way of shadow inventory.  Based on our estimates, there are an additional almost 6 million homes of potential shadow inventory on the market.  This is based on looking at homes in foreclosure or mortgages that are seriously non-current (multiple months of being non-current).

One of the primary issues with the case outlined above is that it is likely there is another leg down in housing prices to the tune of double digits.  This creates negative equity, and negative equity changes behavior of home owners.  According to a quote from CoreLogic on 2/23/2010:

“Once negative equity exceeds 25 percent or $70,000, owners begin to default with the same propensity as investors. The aggregate dollar value of negative equity was $801 billion in 4Q09. The segment of borrowers that are 25 percent or more underwater account for over $660 billion in aggregate negative equity.”

In effect, as homeowners get dramatically underwater, their psychological perception of their home changes and they view it more as an investment in which they may have to sell to cut losses.   As negative equity increases so does the propensity to default.  This creates even more home inventory.  According to Josh’s estimates, almost 4.9 million people are underwater by more than 25%.  Not good.

After painting a completely morbid picture of housing, I’ll leave you with a slightly more inspirational quote from Robert Kennedy:

“All of us might wish at times that we lived in a more tranquil world, but we don’t.  And if our times are difficult and perplexing, so are they challenging and filled with opportunity.”

We do not live in easy times, but opportunities to make money and protect our capital remain abundant.

Keep your head up and stick on the ice,

Daryl G. Jones

Managing Director

Seeing Housing As It Is - p