Thursday, December 16, 2010

On Housing Permits, Starts, and Completions

Much of the news this morning focused on the beat of expectations regarding housing starts, which some are viewing as an indicator of a recovery in the sector.
One issue with using the housing starts data to get a read on this sector is the wide margin of error.
“Privately-owned housing starts in November were at a seasonally adjusted annual rate of 555,000. This is 3.9 percent (±12.0%)* above the revised October estimate of 534,000, but is 5.8 percent (±12.0%)* below the November 2009 rate of 589,000.”

Housing completions suffer from a similar wide margin of error.

Privately-owned housing completions in November were at a seasonally adjusted annual rate of 513,000. This is 14.1 percent (±10.9%) below the revised October estimate of 597,000 and is 39.6 percent (±8.6%) below the November 2009 rate of 850,000.”

A more reliable indicator of the market within this “facts on the ground” release is the housing permits data, as this data is taken from actual public record rather than surveys, and is a better metric for arriving at forward P/E’s for FIRE sector stocks with significant exposure to the cyclical portion of the market. 

“Privately-owned housing units authorized by building permits in November were at a seasonally adjusted annual rate of 530,000. This is 4.0 percent (±2.9%) below the revised October rate of 552,000 and is 14.7 percent (±1.7%) below the November 2009 estimate of 621,000.”

Note that the annualized rate of 530,000 stands in sharp contrast to November 2005, where the rate stood at 2,155,000.

This is important to keep in mind as you’re back testing your valuations.  For example, Toll Brothers (TOL):

KeyBank recently put them at $22, Barclays had them at $21 back in January, and JPM had a target of $29 back in September 2009.  They were trading in the 35 range back around November of 2005.  The permits data indicate that the opportunities to build have dropped 75% since that time, which would suggest a valuation (assuming similar corporate performance) of 8.75.  Obviously there are other factors at play here, but the fact that their past 5 year earnings per share has dropped 78.55% suggests that market size does matter.

Wednesday, December 8, 2010

Municipal Debt Headed South

One provision of the American Recovery and Reinvestment Act (enacted February 2009) was the creation of the Build America Bonds program, which provides special incentives for investors to purchase municipal debt.  The Tax Credit BAB provides a federal subsidy in the form of tax credits to the bond holders, where as the Direct Payment BAB provides a federal subsidy in the form of a 35% cost sharing with the state or municipal bond issuer on the interest of the debt. 
The “big news that didn’t make the news” as of late is that this program appears set to expire at the end of the year with no extension (as some had anticipated as part of the soon to be signed extension of the Bush-era tax cuts).  This will result in a fairly immediate increase in the cost of borrowing for states and municipalities.  Given the already high cost of borrowing for states such as California and Illinois, this will put substantial pressure on the Federal Reserve to start yet another round of quantitative easing in the form of direct purchases of municipal debt in order to keep the costs of borrowing by these states and municipalities low.

Tuesday, December 7, 2010

Reality: The American Consumer is Deleveraging

Adjusting for the FASB accounting changes effective end of Q1 2009, there has been a $105 billion dollar drop in consumer loans since the peak in February 2009, and has been trending steadily down.
What does this mean?  Generally speaking, in a fractional reserve system, debt must increase in order for the economy to grow.  Debt decrease = economic decrease.  Ergo, I would anticipate disappointing sales figures in aggregate when 4Q earnings are reported in January/early February. 

Thursday, December 2, 2010

Pending Home Sales – A Closer Look

Source data:
The current index reading for October 2010 is 89.3.  A 100 reading indicates the level of contract activity as of 2001.  The contract activity is a count of pending contracts, not an estimated sum of overall contract value.  The reading is down from 112.4 in October 2009, and up from 80.9 last month. 
Their staff economist, Lawrence Yun, attributed much of this to looser lending standards and more affordable prices.  The issue I have with this interpretation is:
1.       The lending standards affect the actual sale of the home, rather than the pending sale.  For example, if I enter into a pending contract to buy a home, I still have to then get approval on the financing of that purchase.  Also, a much larger percentage of buyers recently have been all-cash auction purchases, which would not accurately capture the lending environment.  The Federal Reserve Bank of St. Louis has better research on this topic that more specifically addresses real estate lending:

Click on “view data” to get a more granular view, but this shows the actual total real estate loan activity (both existing and new loans) of all commercial banks.

Another group of metrics I really like, these metrics show where the loan officers at banks are actually doing in the mortgage market.  For instance:

This shows that loan officers are actually tightening standards for prime loans.
This shows that loan officers are all but shutting down subprime loans.

In a separate but interesting tangent:
They’re now more than willing to let you ramp up your credit cards.  Go figure.  They love your unsecured debt, but hate your asset secured debt.  Such is the securitized debt markets and funky accounting, where they’re trying to make MBS prettier, while stuffing garbage in consumer debt.   

2.       Median prices are currently at $170.5K vs. $172K October of last year, yet, sales are down 20%.  The price of the home strikes me as being an almost irrelevant correlation here.  Ultimately, most economists view home prices as being stable at 3x median household income.  The current average in the US is $49,777, so the stable median price should currently be about $150K.  As such, current home values are about 13.7% overpriced compared to stable market demand.   

Wednesday, December 1, 2010

A Deeper Dive of Construction Data

Private construction in the residential market was buoyed by home improvement projects, as new housing was down from last month 0.7% and down 7.9% from October of last year.  Spending overall was up 2.5% from last month, and down 9.2% from October of last year.
Private nonresidential construction was down 0.7% from last month and down 20.7% from October of last year.  The only nonresidential area of improvement from last month was in power utilities, which were up 7.8% from last year.  Power utilities are the most significant portion of nonresidential construction, nearly meeting the combined commercial and manufacturing sectors combined in total spending.
Public construction spending was up .4% from last month and up 2.2% from last year.  The two biggest components of the public construction sector are education and roads/highways.  Education spending is actually down 7.4% from last year, while roads/highway spending is up 51.4%.  Oddly, public safety spending is also down 10.7%.  Call me crazy, but I would suggest that budget priorities need to be reconfigured here.