Megan McGrath, analyst at MKM Partners, thinks it's time to take a look at housing stocks, both for a trade and longer term investment. I'm serious. It's an idea so stunningly contrarian, so wildly far from what one would think of in this economic environment, that it simply has to be worth exploring, if only for the thrill of it.
For those just getting here, Homebuilders (XHB) were a group of stocks central to the housing bubble. Formerly relatively staid concerns growing roughly along with the population, the stocks spent decades doing nothing in a gently sloping higher kind of way. Right around late 2002 a confluence events involving cheap rates, corrupt mortgage companies, idiotic ratings agencies, no government supervision, and good old fashioned greed up kicked off an explosive rally.
Stocks like Pulte Homes (PHM), DR Horton (DHI), and a fist full of others rallied over 400% in 2 years before tumbling at the start of 2006. The collapse of homebuilding stocks was a nice signal of the end of the bubble and start of the financial crisis for those who paid attention. Alas, not enough people bothered to notice and the stocks have been dead money ever since.
Which brings us back to Megan McGrath. After confirming that she is in fact serious about being bullish on the group, and after mentioning the fact that many of the banks now in possession of foreclosed homes are simply bulldozing them, I asked her the catalyst for the stocks.
When Pulte and DR Horton report Thursday before the open, McGrath says to pay only passing attention to the headline numbers and instead focus on what she calls the three P's: Progress, pricing, and pace.
Progress toward profitability in spite and because of the seasonally slow 2nd quarter. If the companies can do well this time of year, she reasons, they are likely to be well positioned for more active seasons.
Pricing. Banks may be bulldozing homes they foreclosed on but those are generally in neighborhoods which didn't exist in the first place. Since houses are generally occupied prior to foreclosure, the glut of used homes doesn't have quite the enormous negative impact one might think. Ok, the impact of free used houses on the market is huge, but McGrath doesn't need great pricing power for the homebuilders. She just wants to see margins that stayed stable in Q2. Is that too much for investors to ask? Maybe.
Pace. It's the final P, or rate at which homes are being built. This is a huge one. As economist Gary Shilling told me a few weeks back, there may be as many as 2.5 million homes on the market and/or in foreclosure. That's more than even the most industrious bankers can bulldoze. The normal building rate or pace, for a calender year is roughly 1 million homes. We're not there yet, but again McGrath doesn't need to be. She just needs a number moving in that direction.
Hell hath no fury like jilted investors scorned.
Both short and long term stock investors played the housing bubble long, then short, then not at all. This is the normal circle of life for bubbles and recovery can take a generation if it comes at all. Which is exactly the type of thinking that makes housing an at least intriguing if not convincing idea as a long trade. McGrath likes DR Horton and Pulte both for the next 12 - 18 months and as a trade going into earnings. She's more cautious on Ryland (RYL).
You may not like the idea, but if the time to get long is when expectations are lowest this could be the time to buy the builders.