INVESTING: Weakness in housing could have sweeping implications

In early May, I wrote this about home-builder stocks: “They failed to break out of their August highs, however, and they have been struggling ever since. This is a textbook example of when the best risk/reward ratio presents itself for shorting.”

Using the home-builder exchange-traded fund XHB and selling it short yielded a one-month gain of 18.3 percent. Not bad!

If home-building stocks are crushed, what does that say about the real estate market in general? Here are a few data points before we guess the future. One of my clients sent me this Web site, www.benengebreth.org/housingtracker, which gives long-term trends of prices and inventory for major market in the United States.

There is one common trait that doesn’t paint a positive picture. Over the last nine months, prices are down and inventory is up, way up. Indianapolis slightly bucks the trend, with a small 4-percent price gain, but inventories are up 14 percent.

Some of the hotter markets, like San Diego, saw a 5-percent price decline, with inventory up 43 percent. In Miami, prices are down 8 percent while the number of houses for sale is up 162 percent. The city most set up for a price drubbing is Phoenix, with inventory up 198 percent.

Now that we have some evidence on the table, let’s pull out our crystal ball. The stock market has absolutely laid waste to the home-builder stocks in the last few months.

Prices are pulling back a little, but inventory is exploding. That tells us sellers are not being realistic, and they expect the market to strengthen soon. Prices will follow inventory, and we will see a sharp drop over the next nine months. And as consumers have used their homes to finance all kinds of spending, lower home prices should curtail some of that extra shopping.

With stock markets around the world falling hard in the past month, I would expect to see a change in behavior from the average American.

Stock prices are obvious and in our face, but real estate prices have been declining slowly the last six months, so most people must realize changes are afoot. Yet consumer credit jumped in April, registering the fastest gain in a year. According to Investor’s Business Daily, “Job growth may have cooled and housing activity slowed sharply, but consumers have been willing to spend and load up on debt.”

Keep in mind that interest rates are higher, too. Higher rates are supposed to decrease the demand for credit, but I guess someone isn’t listening.

Even though I accurately predicted this stock market weakness, I’m impressed by the speed and power behind the decline. Japan is still the second-largest economy in the world, and its major index dropped 19 percent in four weeks.

Some emerging markets fell almost 30 percent in the same time. All too often recently, I have heard one of the most dangerous phrases ever uttered on Wall Street: “But the fundamentals haven’t changed.” The stock market is telling us they will, but if you wait around to see how, you could be holding your head in your hands.