Some real evidence of a slowdown .......

One of the drawbacks of working for a traditional institutional asset management firm with a decent amount of assets under management is that I get a ton of Wall Street research and I am expected to read most of it and regurgitated it to colleagues, clients and prospects.

Needless to say that reading this stuff gets old fast so I get particularly excited when something useful/interesting/contrarian comes across my desk. Here is the most relevant excerpt from a recent morning note from Merrill Lynch …..

"Mr. Rosenberg, I have been reading your economic reports since your arrival at Merrill. Last night I began my evening by tuning into Kudlow on CNBC. The topic was as usual "Will the slowdown in the housing sector send us into a recession?"

With that topic on my mind I ended the evening with a group of High School students meeting with a local cement contractor. He began his career 20 years ago with one truck and a second mortgage for capital. He now has 85 trucks that cost $175,000 each and 100 employees with salaries of $40,000 to $100,000. Business has been good the last 20 years. We began asking questions: How is business going? We have some road contracts but the housing business has almost stopped. Will you be buying any trucks this year? No. Will you be hiring in the next 6 months? No. Is there a cement shortage? 2 years ago there was a shortage but no shortage now. How much fuel do you use each month? 20,000 gallons. How much do you spend on benefits and insurance? About $10,000 per employee. Other questions were asked and my conclusions were these. This small businessman will not be buying any trucks this year. His employees who love to buy their own large 4 wheel drive trucks will not be buying either. Less fuel will be bought. Less cement will be purchased. Less money will go into retirement plans. Less money to insurance providers. The only expense that was going up was the legal expense for liens on contractors not paying.

Looks like the housing recession is affecting more people than I thought."

I believe that this is relevant since it provides more evidence in two particular areas of interest to investors……

1) The housing market slowdown is decreasing the amount being spend by Americans in real time and not just because they can’t tap the equity in their home, and

2) it says something when the most relevant piece of Wall Street research I have seen in some time (and I am not singling out Merrill who to their credit have been sounding this alarm for a while) is contributed by a reader.

* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

Watching the sun set ......

While I hate classifications like "value investor" and "growth investor" because by definition every investor is a value investor, if I had to put myself one group I would be in the value camp. I don't think its a stretch to say that just about every value investor is keeping an eye on publicly traded homebuilders as they have been decimated and there will undoubtedly be a very attractive investment opportunity.

The question is .....when?

I will not attempt to predict a bottom in the housing market and homebuilder shares ....not now, not ever. What I will do is share a short "anecdotal" list of things I am watching for to let me know that we are closer to the bottom than the top:

1) multiple bankruptcies of the weakest most leveraged players
2) insider purchase activity at the leading players in the industry
3) large net income losses and massive write-downs
4) largest players in the industry trading below $10 per share
5) politicians become "unanimously outraged" at something
6) nutty valuations

While this list is not in any specific order, my experience has been that when the bubble bursts and things really get hairy, the weakest players are the first to go. We got news on Friday that LEV has filled for Chapter 11. Also, the good people at Calculated Risk report that BZH is having a hard time paying some of its sub-contractors -- not technically a bankruptcy but close enough. My guess is that CHCI and TOA are next.

Points #2 - #4 are fairly straight forward. It looks like the chairman of NVR--probably the most attractive publicly traded homebuilder--just bought a bit over $1M in stock on the open market. Also, I know that I have provided zero evidence that a sub $10 stock price is anything but an arbitrary number and has any meaning what so ever but my experience has been that when this happens across an industry it's a good time to start looking and doing some non-arbitrary research.

Point #5 is a bit trickier but I am basically watching for bipartisan agreement that something bad has happened. When politicians can loudly agree on something it means that the problem has fully materialized and the public has experienced all the consequences -- meaning that the problem is old news, has been priced into the market, and savvy investors have started looking ahead. While its hard to state exactly what the government will do regarding the housing implosion there is no shortage of politicians giving their unanimously outraged opinions on the issue. Watching the Bernake testimony this Thursday reinforced the feeling that politicians are unanimously outraged at what has gone on and are itching to do something that can be used as tangible evidence to their constituents that they are outraged and are doing something about this outrageous outrageousness.

Point #6 should not be on this list because there is nothing anecdotal about it. This is the hardest thing to see and requires a lot of non-arbitrary number crunching. I will be doing more work on NVR (and posting it here) and maybe one or two other publicly traded homebuilders to get an idea of what price represents a truly crazy valuation.

Using my list, if one can apply the old adage that "its always darkest before dawn" to the publicly traded homebuilders than we are watching the sun set and its getting noticeably darker outside.

* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

More pain on the way?

I have been thinking a lot about the speech given by Robert Rodriguez, which was the subject of my previous post. With perfect timing the LA Times ran the following story ominously titled "Foreclosures may spur price drops: On L.A.'s edges, soaring repossessions could set off a downward spiral." (may require a free subscription)

Why shouldn't I just file this story under what I like to call the "new tires effect" which describes a strange phenomenon where I only notice, remember, and take interest in ubiquitous tire commercials exactly 1 week before I get new tires and than promptly forget them after the new tires are installed?

The reason why I think this story is of particular interest and why it dovetails nicely with the speech given by Mr. Rodriguez is because it describes carnage in the real estate market which has not yet occurred and I believe many investors (including myself) may not be factoring into their models for housing related stocks -- home builders, mortgage REITs, mortgage insurers, regional and super-regional spread lenders like WM.

The thing that made this story particularly interesting and different from many of the other "pain in the real estate market" stories that I read almost every day is that the future tense is used as opposed to the present or the past. The authors -- using data from First American which I believe is the same source that Mr. Rodriguez quotes in his speech -- make the point that the cracks are just starting to appear.

The article argues that the marginal ZIP codes in California that should be the first in the nation to experience the real pain have not entered the cycle of spiking repossessions that swell lender's inventories of unsold homes causing them to flood the market which in turn forces individual sellers to lower prices.

Here is an a quote that sums up the tone of the article nicely:

"We're going to have a bear market in housing for a while," said Christopher Cagan, director of research for First American CoreLogic in Santa Ana. "It's going to be bad to be a seller or someone forced to refinance in the impact zone."

Notice that he says that its "GOING" to be bad to be seller which I believe is different from the common perception that right now is the worst time to be a seller and we are now at or close to the bottom of the market and things will turn around before soon.

As I mentioned in my last post, I am taking this opportunity to better educate myself on publicly traded homebuilders. I think homebuilders represent great long term investments since they have a built in growth rate of 6% (3% from population growth and 3% from inflation), their product will never be outsourced, and the industry is still unconsolidated so the top guys can easily grow at 10% to 15% for years to come by taking market share and/or consolidating. However, it seems that the wises thing to do for anyone looking at homebuilders is to adjust their models for the possibility of the real estate market taking longer than a one or two years to recover and adjust their required margin of safety accordingly.