It's only been about two months since I last discussed the homebuilders specifically, rather than housing in general. But given the negative expectations for 2015 margins expressed by KB Home (KBH) and Lennar Corp. (LEN) last week, which caught traders and investors by surprise, this is a good time to revisit the subject.
I've been very negative on the home builders and housing in general for the past year, and have written numerous columns explaining why. I last addressed the home builders specifically in the Dec. 9, 2014 column, As Goes Housing, So Goes the Economy.
In it, I pointed out that most of the home builders stocks had risen substantially from when I had previously discussed the group last August, but that rise did not comport with economic fundamentals, concluding with the statement:
"The totality of all of this is that the expectations for economic growth reflected in the rebound of homebuilders' stocks the past few months are not grounded in the available data on real economic activity. Unless and until there is an increase in real wages, there can't be an increase in demand for the mortgages required to purchase homes."
And in keeping with those observations, since then all of the gains in the stock prices noted in the December column that had occurred between August and December last year, have now been given back as traders and investors are beginning to become aware that of all the sectors available to invest in housing is the most economically sensitive.
Listed below is the performance of the home builder stocks since Dec. 9, 2014, Aug. 13, 2014, and Feb. 19, 2014. Those are the dates on which I've written about the sector and these specific companies within the past year.
The issues raised in each of them are still important.
Toll Brothers (TOL) -5%, -.5%, -10%
PulteGroup (PHM) -2%, -16%, +6%
Lennar (LEN) -8%, +16%, +3%
KB Home (KBH) -28%, -27%, -36%
DR Horton (DHI) -7%, +13%, -1%
Ryland Group (RYL) -8%, +5%, -17%
Beazer Homes USA (BZH) -14%, -3%, -20%
Hovnanian (HOV) -14%, -14%, -41%
This is just plain dismal performance.
The point of this exercise is not, however, to pat myself on the back for having repeatedly made the right call, even in the face of market activity moving these stocks against fundamental potential sporadically. It is to make clear that in order for these companies to have pricing power, and thus earnings potential validating a rising stock price, much more is required than falling interest rates, accommodative monetary policy, and a trend toward loosening regulatory and loan underwriting guidelines.
The industry requires, above all else, demand that is acted upon by consumers, which only comes with rising incomes and expanded job creation. All of the other issues can help potential demand to become real, but without consumer confidence borne of income and job security, they can do little.
This is most evident in the dramatic decline in the 10-year Treasury yield throughout 2014, and continuing so far this year. At the beginning of 2014 the 10-year yield was 3% and the 30-year fixed conventional mortgage rate was about 5%. Today the 10-year yield is 1.8% and the 30-year fixed rate has declined to about 3.75% at par.
I wrote about the fundamental issue of stagnating income growth just last week.
The issues I brought up in that column and the performance of the home builders throughout 2014, coupled with the negative outlook for 2015 as announced by KB Home and Lennar last week, amount to evidence of a serious economic potential issue in the U.S. that is far from being "transitory", regardless of what the Federal Reserve's publicly offered assessment of economic potential is.
One of the issues I've addressed here from time to time is the dichotomy between rising stock prices and falling economic activity. I did so last in the Nov. 3, 2014 column, Global GDP Growth Converges Toward Zero.
The negative global macroeconomic trends noted in that column have continued since, even as U.S. equity indices have continued to gain.
Although stock prices and economic activity are not cyclically linked, they most certainly are secularly, regardless of how much monetary stimulus is supplied to prevent stock prices from declining to meet economic performance and potential.
The performance of the home builders recently may indicate the beginning of stock prices correcting to meet economic reality. The fact that this occurring while the Fed maintains that economic activity is in the nascent stages of accelerating, contrary to substantive evidence to the contrary, should heighten the awareness of every speculator, trader, and investor.