Is the Housing Sector Ripe for a Pullback?

If you keep a close eye on the stock market and the economy, then it’s crucial that you tune out the daily noise. There are so many data points we process that give the impression of a long-term trend, even if it’s really just a short-term shift. 

A few examples come to mind…

#-ad_banner-#The U.S. economy
For anyone tracking the market this summer, you would think its rising value reflects a brightening economy. Instead, the recent gains are largely attributable to expected imminent action from the Federal Reserve and a quiet phase for the European crisis. A broader look at the U.S. economy, extended over a number of quarters, reflects little of the joy the market seems to be experiencing.

Foreclosures on the rise
Another disconnect appears to be emerging among housing stocks, which have rallied sharply for nearly a year. The housing market indeed appears to have hit bottom, and in some markets, home prices have ticked up a bit. But in many respects, this is still a troubled sector, characterized by many foreclosed homes that have yet to hit the market. 

The future of the housing market
In all likelihood, the housing market will be truly healthy — by the middle of this decade. Yet share prices of many homebuilders appear to reflect much stronger sales activity in 2013. Considering the myriad headwinds in place right now, it’s simply hard to see how consumers are on the cusp of a major mood change. And if housing activity fails to take off in coming quarters, then these stocks look awfully ripe for a pullback.

Even if you are a believer in a big-time housing rebound for 2013, you still need to tread carefully with these stocks after such strong gains. That’s the view of JMP Securities’ Peter Martin, who thinks this recent rebound in the housing market is legit: “Over the past two years, the market has experienced several false starts with regard to sustained positive movement in the economy and the housing cycle. However, in our view, this current move appears to have ‘real legs’ given the breadth and extended timeframe of the spring selling season, velocity in which foreclose homes are being cleared from the market, and current pricing for finished lots.”

Yet, even with the fairly positive view, he still says you should brace for a reversal in the housing market. He recently reinitiated coverage of the sector and found few bargains.

Among his pans:

• Beazer Homes (NYSE: BZH). He foresees shares falling by half to a $1.50 price target. He’s concerned that Beazer is likely to keep losing money throughout 2013, and will need to conserve cash, right at a time when flusher rivals can accelerate their long-term land acquisition plans.

• Hovnanian Enterprises (NYSE: HOV). Martin foresees a strong decline of more than 60% from a recent $3.20 a share, as the company faces a possible cash crunch that lead to the issuance of more shares. As of June 30, Hovnanian had $400 million in cash against $1.6 billion in debt. Projections of continued near-term losses will only weaken the balance sheet further.

The analyst goes on to suggest that most other homebuilder stocks are fairly valued, but none look like “buy” candidates, except for one stock: Toll Brothers (NYSE: TOL), which should see a steady upturn in demand, thanks to its focus on well-heeled home buyers looking to take advantage of current low home mortgage interest rates. He notes that “TOL’s integrated operating model and balance sheet offer greater flexibility than its peers,” and he foresees shares trading up nearly 17% from a recent $32.50.

Risks to Consider:  As an upside risk, the direction of the housing market depends heavily on employment trends, so if monthly payrolls start growing at a much faster clip than we’ve seen recently, then these surging housing stocks could keep moving higher. 

Action to Take –> Although the U.S. economy doesn’t look headed for hard times, it doesn’t look to be building a robust head of steam in 2013, either. That’s why it’s wise to keep expectations in check, and book profits in any sectors that already appear to anticipate better days ahead, as is the case with the housing sector.