Builders' Tail Wags the Dog
tail wags dogBy "The Greek"

The National Association of Homebuilders (NAHB) published its Housing Market Index (HMI) Tuesday, and the shares of homebuilders climbed higher on the news. The SPDR S&P Homebuilders (NYSE: XHB) was up 2.1% on the day. However, I’m of the opinion that the tail is wagging the dog here.

First, let me reassure real estate enthusiasts that I agree that the housing market has bottomed and is recovering. I was one of the first to make that call, just see my July 2011 article saying as much, but I have been warning (painfully so) that economic conditions should deteriorate and affect the market for new homes and the shares of cyclical homebuilders. Still, I’ve also advised stock investors that the well-capitalized publicly traded homebuilders like PulteGroup (NYSE: PHM) and Toll Brothers (NYSE: TOL) would continue to gain market share from beaten down smaller builders, and advantage from that.

I’ve also recently suggested that now is probably the best time to buy a home and real estate generally, but I believe that this is a special situation that may not last for long with real estate prices likely to spike along with mortgage rates. I expand on this view in an article I’ve begun working on for Seeking Alpha that I expect to publish shortly. Still, I also believe that for most builders, the HMI better reflects what they are hearing and reading than what they are seeing in terms of traffic through model homes and phone calls for custom builds.

The NAHB surveys builders of all sorts and sizes, and I believe this has been the reason why the index has remained under the break-even mark of 50 for so long. Most builders are still behind the eight ball when you take an all-inclusive look. I bet if you asked the ten largest builders in isolation, you would get a number much higher than 50 on the HMI, but if you asked the 100 smallest, you would find a number far short of the current index. Or, you would find a similar figure, but one built on little tangible reason, because builders like the rest of us, keep reading and hearing about how the real estate market is improving.

Anyway, the December read of the HMI produced the eighth consecutive month of increase. The index edged up to 47, from a revised lower reading of 45 (46 initially) for November. Surveyed economists were in agreement in their forecasts at the consensus, and so the shares of builders rallied Tuesday on the good news.

HomebuilderTuesday’s ChangeYTD Change
SPDR S&P Homebuilders (XHB) +2.1% +59%
PulteGroup (PHM) +3.2% +195%
Toll Brothers (TOL) +0.9% +59%
K.B. Home (NYSE: KBH) +3.3% +156%
D.R. Horton (NYSE: DHI) +2.0% +62%
Beazer Home (NYSE: BZH) +5.3% +32%

* Performance adjusted for dividends and splits

My thesis is reinforced by the NAHB data. While two of the HMI components improved in December to above 50.0, the component measuring the actual traffic of prospective buyers was still just 36, 14 points below the level that would signify a neutral industry observation.

HMI Component IndexCurrent MarkMonthly Change
Current Sales Expectations 51 +2
Forward 6 Month Expectations 51 -1
Buyer Traffic 36 +1


Considering that 50 marks where an equal number of builders find the situation good as find it poor, we would temper enthusiasm about the new home market. And given the gains in the XHB and most homebuilders’ shares this year, there’s all the more reason to expect pushed forward capital gains selling in January. So, if the shares rally some more on a fiscal cliff solution that is inclusive of ongoing real estate incentives, I would take profits in these shares sooner rather than later.

Please see our disclosures at the Wall Street Greek website and author bio pages found there. This article and website in no way offers or represents financial or investment advice. Information is provided for entertainment purposes only.

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