Housing Stocks are Attractive
05/31/10
The stock market suffered its worst May in half a century. Losses of 12.3% since late April soured the mood of many investors. Recovering economic and corporate indicators could not offset the worsening outlooks from Europe and China. After 14 months of stock market gains even the most optimistic people were ready to lend the bears an ear and so the markets sold off. The eerie part was that the same credit indicators that had correctly predicted the declines during the dark days of 2008 and 2009 have also accompanied the current selloff. I am talking of course about credit market indicators such as LIBOR and the TED-Spread. The pullback, amounting to nearly 15% at the intraday Tuesday low, stopped right at the low reached in February, when volatility exploded and risk aversion reached some form of extreme. Investment professionals all of a sudden hated what they used to love - China and emerging markets as well as related themes like raw materials and energy. The beneficiaries of this move away from international exposure have been clearly domestic stocks like regional banks, domestic retailers and - yes - homebuilders. The latter are of course as controversial as ever. After all homebuilders, subprime mortgages and Wall Street were somehow at the root of all evil according to some and homebuilders are among the most hated/mistrusted groups in the investing universe. So let me explain to you the reasons for my belief that homebuilders as a sector have a place in your portfolio. The case is very simple and is based on simple demographic calculations.
The US population is estimated to grow by about 2.7 Million per year. The data for the chart above was taken from the Federal Reserve of St. Louis website and shows a steady population increase. Population growth leads to rising household formation. The number of US households increased on average by around 1.3 million per year (second chart above). That chart also shows how the recession slowed the formation of households dramatically by forcing people to pool their resources more efficiently and for longer periods of time than before 2007. If your son was 20 in 2007 and could not find the means to move out then his 23rd birthday is coming up soon and he may still be living at home. All parties involved continue to love each other, I am sure, but nevertheless look forward to the day when he finally finds his own place. Hopefully that will happen this year. Just as economic distress slows household formation, economic recovery will speed up household formation, concludes USC professor Gary Painter in a paper sponsored by the Research Institute for Housing America, a mortgage industry-backed think-tank. Painter provides one of the most complete analyses of available data to capture what happens to households during changes in the economy. On page 4 of his report he shows how during periods of economic stress and increased unemployment, more people combine households and fewer people leave existing households. As an illustration, take data from Pew Research Center released in March showing that multi-generational households — two or more generations sharing a home — had increased to 16% of the population during the recession. In raw numbers, this means that 7 million more people were living in multi-generational households in 2008 than were in 2000. Professor Painter summarizes as follows:
"The model suggests household formation should increase by about 2 percentage points from current levels by 2012, as people find jobs and recession-induced anxieties abate. That would imply that by 2012, normal rates of household formation should reappear (roughly 1–1.5 million new households per year), but it will take even longer before the U.S. completely recovers from the deficit in household formation caused by the severe recession."
The first market to benefit from the gain will be rental properties. The residential home market should recover more slowly, Painter argues. The drivers that determine the speed of this recovery are jobs and incomes. Let us examine two more charts, that some of you may have seen before in this space:
Construction of new housing units (including rental units w. 5 units or more) crashed to a post war low during this recession. The previous recession lows had been established at 800 thousand units per year. This time though, we did not stop until we reached 479 thousand in April 2009. In April of 2010 we have seen 672 thousand units built, which is the highest number in 18 months but still a long way from the 800 thousand that marked the bottom in previous recessions. Meanwhile, household formation should at least rise to 700 thousand this year and dwindle down the inventory of rental units and spill over into reducing the inventory of unsold homes. Next year, with a million household formations coming our way, we better hope that the several million units of foreclosed homes become available because the market place needs them. Meanwhile, new home sales (2nd chart above) never fell below the bottom range of prior recessions and are now increasing. After I penned my last newsletter about the housing market in June 2009, the SPDR S&P Homebuilders Index (XHB) essentially doubled in price. I am not predicting a doubling again within the next 12 months but I know certain people who even predict a housing shortage in 2012 (rather than the end of the world) and even though this may sound ambitious, they at least have the direction right. Housing stocks may prove to be a valuable addition to your portfolio.
Hermann Vohs
"Love thy neighbor as thyself, but choose your neighborhood."
Louise Beal
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
