Home Sales Analysis Misses the Mark, Providing Buying Opportunities

Friday, August 27, 2010

Lower home sales articles were everywhere this week and were universally loud and dire. On Wednesday, The Wall Street Journal linked almost every market problem to home sales, starting with its front page article proclaiming, “Plunge in Home Sales Stokes Economy Fears” (By Sudeep Reddy and Nick Timiraos, August 25, page A-1).

Here’s what wrong with the reports and how we can profit by them.

Misunderstanding the data and drawing erroneous conclusions

As I explained in “Home Sales Down but Prices Up – What Gives?” (August 6), data collection methodologies for home sales and prices differs, preventing direct comparisons for the same month. In addition, existing home sales and prices information lags by a variable time period (one, two or more months).

These peculiarities make judging the effect of a special event, like the government’s housing incentive, difficult. The two graphs below show the latest reported sales figures for existing and new homes, noting where the effect can be seen. Not only is the timing different, the calculation of existing home sales numbers is hazy.

So, when the news reports say sales dropped 27.2% from June, they should be saying that July closings (representing sales agreements made primarily in May and June – i.e., following the expiration of the government’s incentive plan) dropped 27.2% from June closings (representing a combination of April and May sales agreements).

Now add in another problem: Seasonal adjustment. Because home sales tend to follow a seasonal pattern (higher in spring and summer, lower in fall and winter), monthly figures are adjusted for month-by-month comparisons. The graph below shows those seasonal factors for three sales series (“pending existing home sales” tries to get a jump on the closings report, but is currently available only as an index number).

Note the lag in the existing home sales adjustment, caused by the typical one- to two-month time needed to close the agreed-upon sale.

Seasonal adjustment goes awry when there is an event that disrupts the normal sales pattern. And that’s what happened with the incentive program.

As with any sale or rebate program, buyers are better off making a planned purchase within the period allowed. While those offering the program hope that they entice people reticent to act, they know it will also draw buyers who would have acted later, thus taking from future sales. So, incentive programs produce an abnormal sales bump and a subsequent drop. That’s where seasonal adjustment can distort the picture – by either muting or magnifying the results.

The graph below shows the factors at work.

July’s lower sales (closings), coming in a typically high sales month, were decreased even more (reduced by about 20%). So, even though actual sales were well above January’s and February’s, the adjusted numbers allowed reporters to say sales were the lowest in over a decade. This statement misinterprets what actually happened.

Taking advantage of the “bad” news

Reporters and others took that negative housing sales misinterpretation as more “proof” of an economic slowdown, the chance of a second dip, the expectation of lower housing prices (and deflation) to come and multiple reminders of what we already know – like foreclosures and unemployment.

That sort of analysis is actually unhelpful because it’s too general. The favorite phrase is “global economic slowdown” even as Germany and France – European countries! – experience growth and increased confidence. Looking at home sales for the entire US also misses the regional, local and neighborhood differentiation.

We can take advantage of this academic-like focus and generalized pessimism. There are excellent values in both real estate and stocks – including even homebuilders.

And we aren’t the only ones thinking this way. On Wednesday, The Wall Street Journal also reported “Home Builders Get a Bump as Investors Sense a Bottom” (by Caitlin Nish, August 25, page C-6).

That was followed by its Thursday report, “Toll Is Back in the Black” (By Nathan Becker and Kevin Kingsbury, August 26, page B-3), a positive report on Toll Brothers (TOL), one of the larger homebuilders. In the same issue, “Stocks in the News” included reports on active, bullish trading going on in Toll Brothers (TOL), D.R. Horton (DHI), PulteGroup (PHM) and Beazer Homes USA (BZH). This type of contrarian activity (buying as existing and new home sales reports show sharp declines) can be a good indicator of a possible trend change at work.

So… By understanding housing data, we can better evaluate its meaning. Likewise, we can examine others’ thinking and decide if they are misinterpreting and/or overreacting. If so, we can then search for opportunities currently being overlooked. Homebuilders looks like a good place to start.

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