Sunday, May 07, 2006

House of Cards

This week saw a number of earnings reports from home builders. Although still tryng to paint a rosy picture, they all fessed up to what we already knew: either profits are already down or orders for the current quarter are down significantly while inventory levels are rising:

Of course, all this has been expected for anyone up to date with the websites that keep track of the progress of the housing bubble, e.g., My short position in Beazer Homes (200 sh @ $66.59) has so far gained 12% at Friday's close of $58.50. I have not talked much about the fundamental picture of any company in this blog as that kind of analysis is not one of my strengths. But if one takes a look at the cash flow of Beazer, one will see that despite its record profits, the cash flow is acutally consistently negative as the company not only spent all its earnings, but also issued debt in order to purchase more land. This is the modus operandi of all home builders, of which Beazer is just one of the most egregious. For its leverage, Beazer was rewarded with one of the highest P/E multiples among the home builders. But leverage is a double-edged sword. Now it's time to pay the piper, so to speak.

Despite Toll Brothers finally coming clean with some atrocious outlook, the home builders actually rallied with the market on Friday. The trigger was probably the below-expection payroll number that was perceived to reduce the pressure on the Fed to raise interest rates. I see this bounce from deeply oversold conditions as mostly technical. Due to the large short position in Beazer, it always had the most violent short squeezes. The 200 dma at $64.48 may be tested in a worst case scenario. My short position in Beazer is both a directional play and a hedge to my general market exposure. I refrain from short term trades, but I may add more when this latest move tops out.

One important internet resource is the Housing Tracker which monitors the asking price and inventory levels from the MLS data base. In addition, I check the following blogs daily:

  • Mish's Global Economic Analysis Mish covers global economic trends in depth. There is an excellent article on why the most recent mortgage application showed a month-to-month increase. He has been making arguments for a deflationary scenario as a consequence of the collapse of the housing bubble. I can't say I fully agree because the outcome depends largely on the Fed's and global central banks' collective response, but I always hold his views in high esteem.
  • Calculated Risk This is another excellent blog which keeps track of the new and existing home sales figure, as well as the mortgage application index.
The $64k question is whether the housing market will drag down the entire US economy. The firing of 3,800 workers at Ameriquest Mortgage will not be the last, I fear. On the other hand, the market is making new highs and I'm lousy at calling tops, so my strategy remains reactionary rathan anticipatory.

My wife and I don't own a house. We are currently "house-sitting" for my mother-in-law. The house is paid for so we are only responsible for the upkeep and property taxes. I have largely missed the real estate boom since I have had a "real" job for only five years, but I have no regrets. There is always a bull market somewhere, they say. I'm blessed with a wife who doesn't want one of those 4000 sq ft homes, so we will be more than able to afford our own place when the time comes. We live in an area where plenty of "McMansions" had gone up in the past five years. There has been appreciation but it was nothing like California or Florida. So far there is no obvious decrease in prices either. Toll Brothers reported 45% lower orders in this region so there may be some bargains in the coming months/years. More than anything else, our buy decision will be determined by when my mother-in-law comes back. How's this for a change: housing demand driven by actual need rather than speculative fervor?