Big Fat New-Home Trade (HD)

It’s been a fascinating couple of weeks, no doubt one that historians and social scientists will be focused on for decades.

 

Market historians, too, will find much of interest in this period, we believe, as it marks the transition between the second and final phases of the bull market that began in 2009, or 1980, or 1931, depending upon who’s doing the counting.

 

For our part, it matters little.  The essential thing is that all engines are a go for this last stage, booster rockets have been engaged and capsule separation is now occurring, even as we write.

 

With Dow 19,000 now in the record books, we trudge on to 20,000, perhaps 25,000, and who knows where thereafter.

 

Eerie Glances Back

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That said, it’s not without moments of trepidation that we watch the market action these days, view the economic numbers and dig through the corporate news.

 

For there appears from time to time something eerily reminiscent of those carefree days prior to the Lehman Brothers crash of 2008 that overtakes us – jolts us – and whispers of the need to be circumspect regarding the upcoming run.

 

And nowhere is it more conspicuous than in the real estate sector.

 

For example, the latest housing stats are downright remarkable, and we’re rather surprised they could ever be so, considering how many other parts of the economic engine are rusty and continue to make clunking noises.

 

Consider the following chart that pairs two separate data series for the last two years.  The blue is the current mortgage rate, in red the number of mortgage applications –

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And what it reveals is not altogether mystifying.  As the mortgage rate bottomed out in late summer/early fall and began turning higher over the last six weeks, the number of applications for mortgages began to decline.

 

Sensible.

 

Raise the price, you get fewer buyers.

 

You can therefore imagine our surprise when the latest housing numbers appeared and showed exactly the opposite.

 

Have a look –

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This is a chart of almost twenty years of existing home sales.  And as you can see, we’ve managed to both hit new highs for the cycle and recover roughly half of the losses sustained when sales dropped off a cliff between 2006 and 2008.

 

And that brings us back to precisely those levels last seen when the equity markets were topping and the sub-prime lending fiasco was being revealed for the debacle it was.

 

And we wonder, what gives?

 

Is the latest bout of buying a result of lax lending policies, similar to those we witnessed in the bad old days of the early 2000’s?

 

Possible, but not likely.  The banks are a bit tight these days.

 

And rates look like this –

  • A 30-year fixed-rate Freddie Mac (FRM) mortgage runs on average 3.94 percent this week,
  • A 15-year FRM averages 3.14 percent, and
  • A 5-year Treasury-indexed hybrid adjustable-rate mortgage (ARM) averages 3.07.

 

And that leaves us to conclude that rates may, indeed, be rising relative to where they were a few months ago, but on an absolute scale, they’re still tremendously affordable.

 

And that’s likely what accounts for this –

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Builders have decided to go all in at this juncture, throwing up new structures like kindergarten kids with LEGO – the fastest rate since 1982!

 

And submitting permits for even more –

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And why?

 

It’s most likely they see the writing on the wall.  And that is, that higher rates are now a lock.  There’s no escaping them.  And that means smart buyers will be in a rush to purchase before further rate increases make financing less affordable.

 

And the builders are simply doing what they can to offer buyers as much choice as they can.

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It’s with all this in mind that we turn to the homebuilders sector in order to get a long range perspective on what the stocks have been doing.

 

And this is what we turned up –

 

It’s a weekly paste-up of the SPDR Homebuilders ETF (NYSE:XHB) for the last three years –

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Prices for the stock have averaged $33 over the period and have traded in a very tight range, bouncing higher and lower, but essentially proving nothing and going nowhere.

 

Until now.

 

Currently we have all the moving averages trending higher and price above them all – for the first time in this tightening cycle, a sign that the latest buying action will likely continue.

 

But our trade today is based on just a single component of the sector – and not even a homebuilder, in the strict sense of the word.  It’s Home Depot (NYSE:HD), a company that’s no doubt connected to the building trade and real estate in general and whose stock fares strongest when the builders are active.

 

Take a look at her chart –

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Not only are the stock’s RSI and MACD indicators (in green) now above their respective waterlines – of itself a full-on bullish trade indicator – but we also have price back above all her moving averages for the first time since August, a second green light.

 

All told, Home Depot represents 1) a best-in-its-class bet on a burgeoning real estate sector and 2) a play on a retail sector that’s now also in play.  And our trade this week is an attempt to hone in on the best possible trade for the stock itself.

 

We’re playing it as follows –

 

First, we’re assuming that the turbulence in the $129/130 range is now behind us, and saving a retest of this area, we’re likely due for higher prices ahead.

 

That allows us to sell premium below existing support at HD $125 and use the funds to buy a similarly dated CALL.  And it looks like this –

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Many happy returns,

 

Matt McAbby

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