What Those Collapsing Homebuilder Stocks Are Trying to Tell Us

Finally, some good news for the U.S. economy?

The National Association of Realtors (NAR) just reported July existing-home sales increased in the U.S. housing market to an annual rate of 5.39 million homes—up 17.2% from July of 2012. (Source: National Association of Realtors, August 21, 2013.)

And those companies that are closely related to the housing market like The Home Depot, Inc. (NYSE/HD) and Lowe’s Companies Inc. (NYSE/LOW) reported better-than-expected second-quarter earnings. All these companies cited the housing “recovery” as the reason their earnings did better.

So does this mean it’s a good time to buy homebuilder stocks, or to jump into companies related to the housing market? My answer is a resounding, “NO.”

In fact, the housing market is flashing four warning signs that the so-called “recovery” is losing steam.

First-time home buyers are not entering the housing market. Last month, first-time home buyers accounted for only 29% of all existing-home sales in the housing market, down 15% from July 2012. In a normal market, you’d want t first-time home buyers to account for 40% of all sales.

Mortgage rates are rising quickly. The rate on the standard 30-year fixed mortgage hit 4.6% this morning—up sharply from about 3.5% at the beginning of 2013

For months (in these pages), I’ve been saying interest rates would start to creep up. Even the NAR acknowledges the problem with higher interest rates. Its chief economist, Lawrence Yun, said this week, “Mortgage interest rates are at the highest level in two years, pushing some buyers off the sidelines…the initial rise in interest rates provided strong incentive for closing deals. However, further rate increases will diminish the pool of eligible buyers.” (Source: Ibid.)

The slowing U.S. economy, as evidenced by meager corporate earnings and revenue growth, coupled with jobs growth principally in the low-paying retail and service sectors, will put pressure on the housing market.

Finally, the homebuilder stocks that make up the Dow Jones Home Construction Index, a leading indicator, have been taking it on the chin. This bellwether index is down 25% from the middle of May.

The “recovery” in the U.S. housing market has been nothing like a normal post-bust housing recovery. We’ve had financial institutions come in and buy empty homes at an unprecedented rate and quantity, then renting them out for profit. That’s a temporary fix for the housing market, because these homes will come back onto the market as interest rates rise and these investors shift their capital to higher-return investments. Historically, homebuilder stocks have been a great leading indicator of the housing market. Their recent collapse should be an important warning sign for investors.

Michael’s Personal Notes:

Wednesday’s release of the much anticipated Federal Open Market Committee (FOMC) meeting minutes basically said the Federal Reserve will continue to run its printing presses at the same speed at which they have been running since late last year—until further notice.

So when will the Fed pull back on its $85.0-billion-a-month quantitative easing program?

It depends on economic conditions. The meeting minutes said “…if economic conditions improved broadly as expected, the Committee would moderate the pace of its securities purchases later this year. And if economic conditions continued to develop broadly as anticipated, the Committee would reduce the pace of purchases in measured steps and conclude the purchase program around the middle of 2014.” (Source: Federal Reserve, August 21, 2013.)

There is no clear answer as to when quantitative easing will end, and that causes uncertainty for the financial markets.

If the Federal Reserve decides to taper quantitative easing in September, as many now expect, the pullback will be insignificant. Even if the Fed decides to cut printing by 20% a month, the Fed’s balance sheet will still be destined to surpass four trillion dollars soon! Yes, the Fed will have cumulatively created $4.0 trillion in new money out of thin air!

And let’s face the facts: quantitative easing hasn’t done much for the U.S. economy or for the average American Joe. Quantitative easing has made the banks stronger and richer, while risking hyper-inflation.

One not-so-funny thing: take the earnings of the big banks out of the S&P 500 second-quarter earnings, and you’ll find the remaining companies, collectively, experienced negative earnings growth in the second quarter of 2013. It’s scary stuff—and it’s proof that quantitative easing is helping the banks more than any other sector of the economy.

What He Said:

“When I look around today, I see falling stock prices…I see falling house prices…and prices falling for retail goods stores. The media has it all wrong blaming (worrying about) inflation. In my opinion, the single biggest threat to the U.S. economy and to the Fed in 2008 is deflation. You can bet the Fed will expand the money supply and drop interest rates aggressively as deflation starts to rear its ugly head.” Michael Lombardi in Profit Confidential, December 17, 2007. Michael was one of the first to warn of deflation. By late 2008, the world economies were embedded in their worst state of deflation since the Great Depression.