The 'second wave' of the US housing bust

Eric Fry - Thu 16 Nov, 2006

...During a recent meeting in Baltimore, many of your editor's colleagues discussed the likelihood of a "second wave" of the US housing bust...

 
 
- Even if it is always darkest before the dawn, it is
also pretty dark around midnight. Differentiating
between shades of black is more guesswork than science.
Alan Greenspan says the dawn of recovering will soon
pierce the darkness enshrouding the US housing market.
But we aren't so sure. We're still hunkering down for a
long night.

- Didn't the sun just set on the US's majestic housing
bubble? And didn't the long shadows of falling US home
prices just begin stretching across the nation's real
estate market? How then could the sun be rising already?

- During a recent meeting in Baltimore, many of your
editor's colleagues discussed the likelihood of a
"second wave" of the US housing bust.

- "A second wave is coming," warned Mike "Mish"
Shedlock, "and it's gonna be a lot worse than the first
wave. The second wave will wash over the entire US
economy. We won't just see home prices falling; we'll
see lots of people losing their jobs and lots of empty
shopping malls and lots of bankruptcies. It'll be bad.

- "But haven't the US housing stocks been rallying?"
another editor protested.

- "Yeah," Mish continued, "that's 'cause investors are
already looking for a bottom in this sector, but they'll
be disappointed. This kind of thing always happens when
booms go bust. People assume the worst is over, even
when the worst hasn't even begun."

- "Right," another editor agreed. "Bubble markets almost
always crash in waves. There's usually a big bounce
after the initial collapse. But this bounce usually
fades and leads to even deeper declines. That's what
happened after the US stock market crashed in 1929. It
staged a big rally into the spring of 1930, then rolled
over and tumbled some more. Japan's Nikkei did the same
thing after it crashed in 1990. In fact, it bounced
several times before hitting its ultimate low 13 years
later."

- "The US housing bust is far from over," Mish warned,
"and its gonna get ugly."

- Ironically, Mish uttered these words at the identical
hour that Greenspan was uttered the remark, "Most of the
negatives in housing are probably behind us."
We don't know if Mish is right, but we fear the
Greenspan is close to being entirely wrong. A terrific
report by two analysts at JMP Securities makes the case
that the housing "recovery" is no better than a faint
hope.

- "Based on our field work," write analysts Alex Barron
and James F. Wilson, "we do not believe the worst news
[on housing] is out yet. We continue to see that the
level of discounting to sell homes in the IS is rising
sharply, in particular to move cancelled and unsold spec
homes. And yet, despite the high level of discounting,
buyers are still reluctant to buy."

- The bearish duo issued their grim prognosis early last
month – well before the Census Bureau announced a
stunning 9.7% drop in new US home prices during
September. New home prices had never fallen this sharply
in one year since December 1970, when prices tumbled
11.2%.

- "A little over a year ago, buyers couldn't wait to
sign contracts to purchase homes," a Wall Street Journal
headline recently observed. "Now, many can't wait to get
out of them...New-home builders are taking a big hit
from record numbers of contract cancellations, or
'kickouts.' Fort Worth, Texas-based D.R. Horton Inc.,
the US's biggest developer, says its cancellation rate
is currently 40%, compared with 29% a year ago.

- Meritage Homes Corp. in Arizona is reporting a 37%
kickout rate, compared with 21% a year ago. And Standard
Pacific Corp. says that 50% of its contracts fell
through in the third quarter of this year, compared with
18% for the same period last year."

- But these troubling facts have not dissuaded Alan
Greenspan and other economic cheerleaders from
predicting a recovery in the US housing market.

- "The worst is behind us as far as a market
correction," declares David Lereah, NAR's Chief
economist. "This is likely the trough for sales. When
consumers recognize that US home sales are stabilizing,
we'll see the buyers who've been on the sidelines get
back into the market, and sales will be at more normal
levels..."

- Analysts Barron and Wilson disagree. The prognosis for
the US housing market remains very poor, they contend,
and it remains particularly grim for the builders of new
homes.

- "America's housing market is landing harder than most
people realize," they warn. "As we study the number of
listings versus homes sold across various price ranges,
what we find is major disconnect between the prices
where the majority of the listings are and the prices
where the majority of the sales are transacting.

- For example, in Phoenix, Arizona, 63% of the sales and
46% of the listings in July were for prices under
$300,000, resulting in a 4-6.5 months' supply of homes
in this price range. However, for prices over $300,000,
which is where most builders had been building last
year, the months' supply is 9.5-14 months." From the
perspective of publicly traded homebuilders, therefore,
the housing market may be even worse that it appears to
be on the surface. And clearly, signs of a bottom remain
elusive.

- "We continue to look for signs that a recovery is
imminent," said Robert Toll, the CEO of Toll Brothers,
the US's leading home builder, remarked last week, "but
can't say that one is in sight."

- Yet, despite these cautious remarks from the leaders
of the homebuilding industry, investors are throwing
caution to the wind. Homebuilding stocks bounced 6% a
few days a go – punctuating a rally that has lifted the
sector more than 20% since mid-July. But analysts Barron
and Wilson would advise against bottom-fishing among the
homebuilding stocks.

- "Historically, we see that speculative excesses
generally take longer than one year to work themselves
off. So far, the US housing stocks seem to be closely
tracking the Nasdaq decline after it peaked in March
2000. Thirteen months after the peak, the Nasdaq was
down 60%. This was followed by a brief rebound that
lasted three months and took the index up 17% from its
lows. Subsequent to this brief rally the Nasdaq fell
another 30% over the next three months to a lower low.

- The Nasdaq eventually bottomed out three years from
the peak in March 2003, 75% below its all-time high. The
homebuilding index peaked in July 2005 and then fell 50%
12 months later. [But, over the last three months, the
index is up 21%]. We believe the US housing stocks are
likely to re-test their lows in the coming months and
perhaps go below them before we see the ultimate
bottom."


Regards,

Eric Fry
for The Daily Reckoning