On July 8th, in an article titled, “The Housing Crisis: Denial is the first stage” (which was posted the following day, and you can still find it in our archives), I discussed the problems with the current housing market and why the situation seemed grim. The conclusion of the article included the following excerpt:

“…I will issue a blanket statement urging people not to look for bottoms in bank stocks, housing stocks, and yes, even Fannie Mae and Freddie Mac. These stocks have gotten crushed, but I’m not convinced that they can’t get stepped on further…”

Everyone is wrong from time to time. I am wrong from time to time. This is not one of those times.

Some banks stocks have gone up a little. Some have gone down a little. Same with homebuilders. However, those of you who ignored my advice would have lost more than 70% of your investment in Fannie Mae (FNM), and even more in Freddie Mac (FRE). Each of these stocks have been pummeled into the low single digits, when in early July analysts were plastered across a four-way split-screen on CNBC touting the stocks as “cheap” because they had already fallen off a cliff.

My motive in drawing attention to this is not to boast about my recommendations because, as the saying goes, even broken clocks are right twice a day.

Instead, I’m trying to highlight examples of how even in periods of pessimism, things can still get worse.

Homeowners are still in denial

Most people refuse to admit (or believe in the first place) that they’ve made a mistake. I’m not referring to the purchase of a home, but rather to the belief that because they bought that home, then it should appreciate in value the same way residential real estate has over the past decade or so.

For example, my friends and neighbors. These people know that I am involved in financial markets. On a weekly (if not daily) basis I see nervous desperation in their eyes as they make their inquiry, “so… do you think this housing market’s going to pick up soon?”

Yeah. It’ll pick up by next Wednesday.

We live in an impatient world, and our demand for short-term gratification in all aspects of life is perpetually increasing. When we make an investment, such as purchasing a home, we don’t want to wait for it to appreciate. This is where “hope” takes over for “reason”.

In that case, I hope I find a suitcase of cash on the way to the office tomorrow.

What does the future hold for home prices?

Guess what? Housing prices, in order to stay along their current trends, would need to fall another 15-20% to reach a reasonable level. This could be achieved by an immediate drop or by flatlining for 8-10 years. My guess would be a mix of these two scenarios, seeing a slight decrease over the next 5-6 years.

Supply and demand are what drive prices, not only of homes, but of equities, currencies, commodities, and anything else that can be bought or traded.

Well, supply is high. Demand is low. Sigh.

Over the past five or six years, the periods of record lows in the federal funds rate have mesmerized consumers who have been taking advantage of bargain fixed-rate mortgages. Many people have refinanced or purchased new homes during this time because of the bargain interest rates. This has caused a reduction in demand by itself, purely because people do not buy houses with the frequency in which they buy food, clothes, cars, or darn near anything else.

There’s something simple that can increase supply: a “for sale” sign.

We’re in a predicament where fear has pervaded, and there exists a certain percentage of homeowners who have placed their house up for sale purely because they are terrified to wait until it loses even more of its value. This is compelling those persons who are forced to sell their homes for various reasons to lower their prices further in order to get out.

Let’s look at some numbers:

Last month, housing starts fell 11% to a low we haven’t seen since the 1991 recession. Housing permits (which are usually a measure of builders’ confidence in the market) fell 17%. In fact, a survey of the National Association of Home Builders stated that only 8% said they see a favorable market in the next six months.

To add fuel to the fire, the most common times for residential real estate activity is mid-spring to early summer. There are several reasons for this, such as school enrollment for children and cooperative weather for moving.

Do you think that the houses that have been for sale for months (or in some cases, years) are suddenly going to sell as demand slows down during the fall and winter months? I don’t either.

Is my home, or real estate in general, a bad investment?

Generally… no.

The difference between a house and a share of stock is that a house is tangible. You can use your house. You can’t turn in a share of stock to a company and receive a chair in return.

However, there are plenty of opportunities to make poor decisions with real estate.

Have Fannie Mae and Freddie Mac hit a bottom? Should we buy housing stocks now or sell them? What about bank stocks?

I’m not going to say FNM and FRE haven’t bottomed. It’s completely possible that they have. However, when you take into account how contrived these companies are in their very existence, as well as the uncertainty surrounding the possible bailout of these organizations by the government (including the time frame with which this could occur; some analysts say it could be a 3-4 year process), even if they’ve hit bottom, it’s hard to determine just how much they’re going to travel to the upside.

As if the bad news weren’t enough, homebuilding stocks such as Toll Brothers (TOL), Centex (CTX), and Pulte Homes (PHM) all show technical resistance in the areas they are currently trading, so it is not an ideal time to purchase.

If you’re like most American homeowners, your house hasn’t appreciated much in the past year or two. Do yourself a favor and avoid vehement, long-term hatred for the real estate market by not risking your spare investment dollars right now in these stocks.

John K. Whitehall
Analyst, Bourbon & Bayonets