Housing Bubble Threat Means Sell These Stocks

The recent rumors of a housing bubble have chilled the recent rise in homebuilder stocks, which were one of the great stories of 2012.

They had underperformed badly for several years in a row as a result of the credit crisis. Foreclosures and other distressed properties were clogging the marketplace and there was very little demand for new homes. Many of the stocks were still losing money and almost all of the homebuilders traded for less than their book value.

But the housing market began to show some signs of improvement during the year. The S&P Exchange Traded Fund (NYSE: XHB) rose by more than 50% during 2012 and many leading builders performed much better than that. Shares of The Ryland Group Inc. (NYSE: RYL) rose by more than 100% while Hovnanian Enterprises Inc. (NYSE: HOV) and PulteGroup Inc. (NYSE: PHM) saw their shares rise by more than 150% during 2012.

We have seen improvements in the Case Shiller Index of housing prices, up 4% through October of 2012. Housing starts in December were at the highest level since 2008. Foreclosures fell to an almost six-year low in December.

The end result of all this positive news is that Wall Street started falling all over themselves in a rush to upgrade and recommend the homebuilding stocks.

But before investors embrace the enthusiastic support of homebuilding stocks it might be best to take a step back and look at the whole picture.

The Real Story with Homebuilder Stocks

While housing prices have improved they are just now approaching the levels of a decade ago in most metropolitan areas of the country. Housing starts may have leaped ahead in the last month of 2012, but they are still just a fraction of the monthly homebuilding activity at the peak in 2007.

While foreclosure activity slowed at the end of last year it is expected to accelerate again in 2013 as new regulations force banks to foreclose quicker than they have been doing during the credit crisis.

Although the shadow inventory of homes is shrinking somewhat there is still a supply of 7 months still to hit the market. These homes are either owned outright by banks and not yet on the market or in various stages of the foreclosure process. This inventory will keep a lid on the housing market for much of 2013.

Some have gone as far to say there's a collapse coming in the market.

David Stockman, former director of the Office of Management and Budget under President Ronald Reagan, thinks so, recently told The Daily Ticker, "I would say we have a housing bubble again. I don't think we have a real, organic, sustainable recovery."

Although the market is better than it was it is still not robust at this point in time. Housing prices could well bounce along the bottom well into 2014 before staging any real recovery.

Any additional economic damages caused by fiscal issues out of Washington could cause the market to stall and even decline once more very quickly – causing a burst in the housing bubble.

Then there is the evaluation of the homebuilder stocks at this point in time. Today most of these stocks trade well over book value and that is usually a topping point for these stocks.

Lennar Corp. (NYSE: LEN) shares trade for about 2.5 times book value, as an example. That's about the valuation point the shares reached as they topped out in the boom years of 2005 and 2006. Ryland traded at more than three times book value at its peak in 2005. Today the shares fetch 3.6 times book value.

The same condition holds true for most of the stock in the industry. They are at levels usually associated with a peak in prices – not a buying opportunity.

Bottom Line: The housing recovery will not be a V-shaped recovery. A full recovery will take years not to months to play out. As usual Wall Street is too excited too soon and has pushed homebuilder stocks to unsustainable levels. Investors who were lucky or smart enough to catch the ride should be looking to sell the shares and lock in gains, if they haven't done so already.

Aggressive traders should start looking for entry points to short the shares and profit form what appears to be an inevitable decline as the threat of a housing bubble looms.

Related Articles and News:

• Money Morning:
  Is This a Recovery or a New Housing Bubble?
• Money Morning:
  Case-Shiller Home Price Index and Home Sales: What the Latest U.S. Housing Market Data Show