Bottom line - Inventories Are Rising & Better Than Expected Sales Are the Calm Before the Storm
June existing home sales were better than expected due to the continued effect of the April 30 tax credit expiration pull-forward. June sales came in at 5.37 million (seasonally adjusted annualized rate) down 5.1% from 5.66 million in May, as compared with consensus expectations for a decline of 7.7%. Remember that this June print is a lagging indicator as it reflects deals closed two to three months ago (Apr/May) because of the 30-60 day lag between signing and closing. We would expect the next 3 months of data to get very steadily worse. Moreover, the Administration may be moving in a direction away from supporting homeownership. This was profiled in a Washington Post article yesterday which we summarize and provide a link to at the end of this note.
Inventories of homes for sale rose this month on both a units and months basis. Inventory rose to 3.99mn units from 3.89mn units in May, a 2.6% increase. We think inventory levels are particularly important as these are the unknown in the price equation. In other words, these sales numbers are lagging - we already know what they'll be based on purchase applications that come out almost in real time, but the inventory numbers are new and there is no market proxy for this, so the uptick in inventory in June is very significant and sows the seeds for an 11-12 month supply figure in the next two months, which should be a wake-up call to the market that the housing market is poised for further decline.
Another way of putting the current environment in context is comparing it to the comparable period following the first tax credit stimulus. In other words, how does it compare with the average of the November & December 2009 prints of 5.96mn. Against that measure, sales are down a considerable 10% (5.37). Remember, the original tax credit expired in November, 2009. The current credit (for closing) expires September 30 (April 30 for signing), which means the average of November/December 2009 should be comparable to June 2010 (which reflects April/May activity).
It's clear that tax credit round two is having a less substantive effect on sales than round one did back in late 2009.
Inventory, on a units basis, rose 2.6% to 3.99 million units from 3.89 million units in May.
Inventory, on a months supply basis, rose to 8.9 months from 8.3 months last month. While inventory is up this month, it is well below where inventory is headed because its keying off a still artificially high June 2010 sales rate. If we assume that the same dropoff in sales occurs following this tax credit expiration as followed the last tax credit expiration we can expect to see a sales rate of 4-4.25mn a few months from now. Meanwhile, inventory is at 3.99mn units. In other words, inventory should rise to 11-12 months or higher in the next few months.
Our view is that this pull forward of activity is setting the stage for a much weaker-than-usual summer housing environment. Housing-sensitive stocks could be at risk heading into the 2H10 and 2011 time frame.
Washington Post Reports Obama Will Back Away From Support of Housing Market
On another note, there was an article in yesterday's Washington Post entitled "Obama's next focus of reform: Housing Finance" (link provided below), in which author Zachary Goldfarb reports that the Obama Administration will do an about-face on housing in the not-too-distant future following the passage of FinReg. According to Goldfarb, the Administration will back away from the oft-touted Clinton and Bush Administration maxims that homeownership for the sake of homeownership is good, and will implement new policies that would favor low-cost renting as opposed to owning, such as winding down government support for home loans. The author cites Raphael Bostic, a senior HUD official, as saying "In previous eras, we haven't seen people question whether homeownership was the right decision. It was just assumed that's where you want to go. You're not going to hear us say that." That said, Goldfarb quotes another Administration official - Andrew Williams, Deputy Assistant Secretary for Public Affairs - saying "You are overreading some kind of hard pivot here."
We would encourage investors to read the article directly rather than our summary above:
New Home Sales Rise Vs. the Lowest Reading Ever Recorded - Is This Really a Catalyst?
Yes, new homes sold in June rose to a seasonally-adjusted annualized rate of 330k, up 23.6% from a downwardly revised May print of 267k (revised from 300k). Should we get excited? Relative to bearish sentiment, perhaps this is good news, but we think it's temporary and doesn't change the bigger picture. As the following chart shows, new home sales of 330k are the fifth lowest reading ever recorded and squarely in the bottom of the range this data series has seen. While it's true that less bad is good, the relevant question is duration. Investors should ask themselves, if new home sales remain in a ~300k range +/- 30k for the next several years, as we think they will, will that be good enough for the stocks to work on any duration longer than the short term?
The housing market has caught three positive datapoints in the last week. MBA mortgage purchase applications posted a 3% sequential rise last week. Existing homes sales data released on Friday came in better than expected, and this morning new homes sales data showed month-over-month improvement. We think this string of positives has managed to give a nice short-term lift to all housing-related sectors. By way of example, the XHB homebuilder ETF is up 12.2% off its July 2 low after falling 28.6% off its April high. This retracement is setting the stage for the Second Act.
The one positive we'll afford the new home market is that inventory is low. In fact, it's at an all-time low of 210k. Clearly this is positive. The question, however, is whether sales come back to anywhere near where analysts think they will in a 2-3 year timeframe. We don't think so. For further information, refer to our recent note examining the concept of cumulative displacement of new home sales in this cycle relative to prior cycles.
Joshua Steiner, CFA