The housing market is showing signs of stabilization. The free fall in home prices appears to have ended. Even though foreclosures are on the rise, strong increases in sales are enabling home prices to stage a modest rebound.
Home prices as measured by the S&P/Case-Shiller index advanced 1.4% in June. This marks the second straight monthly gain for the battered housing market.
With home prices showing signs of turning around, it pays to look at leading indicators of supply of and demand for homes to assess whether the bottom can be enduring.
Supply of Homes
New construction as well as foreclosure contributes to the supply of homes.
Issuance of building permits is a leading indicator of new construction activity. There is ample evidence that construction activity is slack. Number of building permits is down nearly 40% on a year-over-year basis.
Foreclosures are however a point of concern. The U. S. foreclosure rate shows no signs of abating. The foreclosure rate could also increase materially if forecasts for a double-digit unemployment rate come true.
Demand for Homes
Pending home sales are a useful leading indicator since they track contract signings. Here the picture is encouraging.
The National Association of Realtors recently announced that pending home sales gained 3.2% in July. Coming on the heels of a 3.6% increase in June, this marks the sixth straight monthly gain in pending home sales.
With frugality being the new norm for consumers, purchases of smaller sized homes are becoming more common. The average size of new homes is down to 2,065 square feet. The Commerce Department's data show that sales of new homes costing less than $200,000 accounted for nearly half of all sales in the first half of 2009.
What This Means for Home Prices
As long as the job market doesn't get much worse and mortgage rates don't rise too much, home sales should continue to trend upward and help home prices recover further. The strength of the recovery is likely to be subdued and the duration drawn-out as high levels of foreclosures offset restraint on new construction.
Given the above outlook, it is right to get into housing-related investments... but selectively. We believe new starter home builders, home improvement companies, and selected home furnishings makers can prosper as home prices recover.
First Time Homebuilders
Mortgage availability is less abundant than in the go-go days. Added to this, uncertainty on the job front is running high. These factors are working to curb consumers' appetite for large mortgages. Against this backdrop, the lower-end of the house price spectrum appears more appealing than the higher end.
Shares of lower-end homebuilders offer one way to play the housing recovery. D. R. Horton (DHI) and KB Homes (KBH) are examples of homebuilders catering to first-time buyers.
Home Improvement Companies
The backdrop of modestly rising home prices and lower mobility from a slack job market is likely to encourage homeowners to upgrade their homes. Home improvement companies like Home Depot (HD) and Lowe's (LOW) can fare well in this milieu and offer another means to play the housing recovery.
Home Furnishings
Teeing off the potential for homeowners to upgrade their homes, makers of home furnishings that help to increase the value of homes look appealing as well. Masco (MAS) a maker of cabinets, plumbing products, and paints is an example that fits this bill. Floor covering product maker Mohawk Industries (MHK) is another company that can benefit.
