Lack of Economic Data Hiding True Health of Housing Market

One of the difficult situations that arose from the U.S. government shutdown was the lack of economic data. Since economic data is extremely important to fine-tune your investments, without it, investors are essentially driving in the dark. With the decision to push back the debt ceiling and temporarily reopen the government, we’ll likely see some data coming in over the next few weeks.

However, in the meantime, there are still private organizations that have been issuing their reports on economic data throughout the U.S. government shutdown period.

The latest report on the housing market is by the National Association of Home Builders, with the Housing Market Index (HMI) dropping to 55 in October—a four-month low, and lower than the expected 58. (Source: “Builder Confidence Down in October,” National Association of Home Builders, October 16, 2013.)

The survey is interesting because, normally, homebuilder stocks as a group are quite optimistic. This confluence of negative variables, including higher interest rates and the government shutdown, has had an impact on the housing market, trickling into the sentiment of the homebuilder stocks.

While the government freeze is now over (at least for now), higher interest rates are still with us. While mortgage rates remain near historic lows, the move up in interest rates over the past few months has caused a significant dent in the housing market.

What this tells me is that the average American is far more worried about their future than many analysts would like to believe.

While the survey does indicate that optimism among homebuilder stocks still remains positive, the drop in confidence is noteworthy. Frankly, I’m not surprised; these things tend to be cyclical. Markets overshoot to the bottom, rally up, and overshoot at the top.

From the depths of the recession a few years ago, clearly, the housing market was oversold and ripe for a reversal. Homebuilder stocks were in the right place at the right time, with sentiment being extremely bearish. At that point, a turnaround in the housing market was extremely positive, as expectations were so low.

Fast-forward to today, and homebuilder stocks are fully valued, in my opinion, for the current level of the housing market. Any marginal slowdown going forward in the housing market would be quite negative for the homebuilder stocks.

I know what you’re thinking: homebuilder stocks have already sold off this year; isn’t that enough?

Take a look at the chart below, and you will see that the current price of just one of the homebuilder stocks (Lennar Corporation [NYSE/LEN]) still remains at extremely lofty levels.

Chart courtesy of www.StockCharts.com

I’m not suggesting that homebuilder stocks will necessarily crash to the depths reached during the last recession; what I am saying is that there is limited upside left in these companies—and much larger downside potential.

I’m guessing you’re thinking, if the Federal Reserve continues buying mortgage-backed securities, won’t that keep boosting the housing market?

Over the short term, yes. However, we all know, and this was fully disclosed in the latest Federal Reserve meeting minutes, that the asset purchase program will end sometime next year.

Will that be a positive or negative for the housing market? On the margin, I would say negative.

While the Federal Reserve might not begin increasing short-term interest rates, it might not have a choice due to long-term interest rates. Over the last few days, China voiced its disapproval of the way our government is handling its finances, most recently downgrading the U.S. credit rating.

China is the largest holder of our debt. What if over the next five to 10 years they decide to reduce buying our debt? Is that positive or negative for interest rates? On the margin, I would say negative (meaning higher interest rates).

My point is this: while the housing market has made a strong recovery and homebuilder stocks have gone up significantly, don’t expect this trajectory to continue forever. There are still massive headwinds, and I think far too many people are complacent in this current market. At this time, I’d suggest investors approach the “recovering” housing market and homebuilder stocks with a great deal of caution.

This article Lack of Economic Data Hiding True Health of Housing Market was originally published at Investment Contrarians