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  1. Home
  2. / Investing
  3. / Real Estate

Despite Home Depot Results, Be Cautious on Housing Stocks

New starts rise may be more of a snap back than sustainable upturn. 
By CHRIS VERSACE AND LENORE HAWKINS May 20, 2015 | 05:00 PM EDT
Stocks quotes in this article: HD, LOW, TOL, DHI, PHM, WSM, RH

The U.K.'s deflationary scare this week, with CPI dropping 0.1% in April, wasn't the only nail-biter.

The markets overnight got a powerful reminder that the seductive opportunities presented by emerging markets are accompanied by heightened risk. The maker of solar equipment, Hanergy Thin Film Solar Group, dropped 47% before trading was halted in Hong Kong, erasing over $18 billion of market value. Trading was halted per a request from the company pending an announcement. Errr, what!?

A few weeks ago Hawkins had the good fortune to speak with one of her favorite global investors, Louis-Vincent Gave, at the Altegris Strategic Investment Conference in San Diego. He  claimed, "The world's single largest crowded trade, the trade that everyone in this room has bet on and doesn't even realize you've bet on is the absence of China in your portfolios." Louis, you may be right about the trade, but we're betting that a few more wished they were short today!

We agree with Gave that China will eventually have an enormous impact on the investing world, given that it is currently completely absent from global bond indices and represents only 1.7% of the Global MSCI all country index. But there is still a good deal that needs to be worked out before China is ready for primetime.

In the interim, for those investors that would like to get involved, we highly suggest limited company specific exposure, opting instead for funds such as iShares China Large Cap ETF (FXI) or Market Vectors China ETF (PEK).

In the U.S., the data and earnings releases coming out this week have been primarily focused on just exactly where that wily American consumer is spending. Most of the retailers have been struggling, but Home Depot Inc. (HD) managed to beat both top line revenue and profit expectations with same-store sales up 7.1% and earnings at $1.16 a share, again beating expectations, if only by a penny. The September 2014 data-breach is still weighing on the stock, however, as the company reported that it currently isn't able to accurately estimate the range of costs. But it did raise guidance for the remainder of the year, albeit that raised guidance was essentially back to where it was last quarter.

The company's share price remains slightly below its 52-week high and while the fundamentals of this business look strong, Hawkins' take is the price today is rather rich and one should wait for a market pullback to build any meaningful position. Versace sees 10%-15% upside in HD shares, but that's not enough to get him interested. He'd rather be a buyer of HD shares closer to $100, which offers a far more compelling risk-to-reward tradeoff.

If you already own HD shares, we both think you should continue to hold 'em.

In contrast, the other major home improvement chain Lowe's Companies Inc. (LOW) reported weaker-than-expected profit and revenue growth in its first quarter, causing its shares to fall 6.6% in premarket trading, with profits of just $0.70 a share vs. expectations for $0.74, which brings us to the latest housing sector report.

Tuesday's report from the U.S. Census Bureau that April housing starts were well above expectations may have some thinking that this sector is potentially heating up. We'd caution a deeper look at the data, pointing out that February and March starts were considerably lower than what was implied by permits. A catch up in starts was inevitable. We will likely see another beat next month if the catch-up continues and aren't ready yet to call this a definitive and sustainable upturn.

Besides, despite the better-than-expected April Housing Starts figure, the National Association of Homebuilders (NAHB) Housing Market Index dipped month over month in May. As NAHB Chief Economist David Crowe put it, "Consumers are exhibiting caution, and want to be on more stable financial footing before purchasing a home." To us that sounds more in the snap back than sustainable upturn camp, but we'll let the data tell us what's really going on.

When it comes to home ownership, we continue to look primarily to changes in income levels and interest rates for confidence in a longer-term uptrend. Unfortunately, median household income declined in March, (latest data available) according to Sentier Research and is now 5.3% lower ($3,020) than its most recent high in January 2008 and over 4.5% below where it was in 2000.

Despite all the hoopla over supposed household deleveraging, according to a resent Bloomberg report, "total mortgage principal outstanding as a portion of disposable income and foreclosures as a proportion of mortgage loans outstanding remain elevated relative to previous multi-decade historical averages."

With income still weak, debt level relative to income still high and data trends pointing towards a steepening yield curve, any improvement in the housing sector is likely to be muted. That has us still staying on the sidelines when it comes to homebuilding stocks like Toll Brothers (TOL), DR Horton (DHI), PulteGroup (PHM) and the like. Looking at the charts of those and other homebuilders over the last six weeks, staying on the sidelines has been the right call.

That isn't to say that there aren't any opportunities in the housing or home-related sectors. In a testament to the split between the haves and the have-nots, premium brands like Williams-Sonoma Inc. (WSM) and Restoration Hardware Holdings (RH) have posted impressive results in 2014, up nearly 20% and 43% over the last 12 months, respectively. We will be digging deep into WSM's earnings,  announced after the market's close today, for signs that the higher end of the market is still going strong.

This afternoon, we will also be digging deep in the more detailed account of the Federal Reserve's April meeting, which was released today at 2:00 p.m. EST, for further insights into members' views on a rate hike. We believe the hike is increasingly unlikely this year. Even so, we'll still listen to Janet Yellen's speech this Friday for possible clues on that rate hike.

Finally, tonight, after a victory lap lasting several weeks, David Letterman will say his adieus after 33 years on the air as a late-night host. Dave, you've made us laugh. You've made us think and you've often made Hawkins throw things at the TV. We wish you well and we'll be watching to see if that last musical guest is Dave Grohl, Bruce Springsteen, or both. 

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

Lenore Hawkins and Chris Versace have no positions in any companies mentioned.

TAGS: Investing | U.S. Equity | Real Estate | Economy

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