Looking back to the beginning of the current recession, there were two things that initially put the brakes on the economy: 1.) the sub-prime melt-down and 2.) virtual halt of residential construction. They go hand-in-hand. As new homes are constructed, many were being bought by those wanting to upgrade. In turn they had to sell their house. Eventually, as new home construction expanded while the buying population shrank, the only way to feed the beast was to expand the sub-prime market. Like most houses of cards, ultimately it failed. Has housing finally hit bottom?
I am not ready to call a bottom, but recently there has been some encouraging news. First, the Commerce Department reported housing starts jumped 22% in February to a seasonally adjusted annual rate of 583,000 from a revised 477,000 in January. This was the biggest percentage gain in 19 years. Single-family home construction increased 1.1% last month, and new construction of multi-unit buildings surged 80%. Building permits rose 3% in February, according to the Commerce Department report, to an annual rate of 547,000. Building permits are considered a reliable indicator of future activity in construction. This should be good news for homebuilders such as DR Horton Inc. (DHI), Toll Brothers, Inc. (TOL) and Pulte Homes, Inc. (PHM) who have seen their share prices collapse over the last 18 months.
Though some economists are inclined to write this off as a weather-related fluke, one homebuilder is saying that conditions are improving slightly in the industry. “Traffic is definitely up, and the number of contracts for houses has doubled on a per-month basis since October,” said Ara Hovnanian, CEO of the homebuilding company Hovnanian (HOV).
Another sign of the thaw came March 17th when an analyst upgraded home improvement retailers Home Depot Inc. (HD) and Lowe’s Cos. ( LOW) citing the HD’s cost-control efforts and the LOW’s potential for expansion as reasons. Home Depot’s cost control efforts, fewer store openings and strong free cash flow helped the company deal with the troubled housing market. “Home Depot is demonstrating strong capital discipline. The company is spending cash wisely and only opening 12 new stores this year,” Binder wrote in a note to clients.
In another note, Binder said Lowe’s may be able to gain ground when people start looking forward to new store openings again. “While it doesn’t feel like we need any more home improvement stores, Lowe’s has half the number of stores Home Depot has in many major markets and convenience matters in this business. In other words, the company could get credit again at some point for having more unit growth opportunities relative to Home Depot. While spring selling will give us a better feel for inventory levels during prime selling season, we are encouraged by greater affordability and possible improvement in banks willingness to lend as bank balance sheets see some repair.”
We must continue to cautiously manage our portfolios in this downturn, while keeping a watchful eye on our surroundings. Signs of new life make it easier for long-term investors to stand firm in their convictions.
Full Disclosure: Long HD