Housing – Looking Over the Edge of a Cliff

After underperforming during winter 2014, March’s housing market data was expected to rebound. That did not happen, and housing remains crucially poised at the edge of a cliff, with higher home prices it seems the only protection.

March’s new home sales data showed a 13.3% decline year over year. Existing home sales fared even worse, falling for the third straight month and seven out of the last 8 months. So much for the weather rebound!

The existing home sales number of 4.59 million was the lowest since July 2012. The first chart below shows that the supposed housing rebound is certainly not in the numbers of transactions.

But although fewer homes are being sold, prices remain elevated. What is going on?

Mortgage Applications

Analysis provided to our subscribers in November showed that the number of traditional homebuyers, those using mortgages, was crumbling. Since November those numbers have only gotten worse as mortgage applications in 2014 are already down 19% from a year ago as refinances also dry up (now down 73% since last May).

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The number of mortgage applications today are synonymous with the numbers from the late 1990s, a remarkable statistic given the numbers aren’t adjusted per capita (for growth in the population).

Implied by the drop in mortgages the first time homebuyer is also disappearing from the mortgage market as they can’t afford the higher home prices.

Once 37% of the market in 2012, the first time homebuyer now is only 30% of the home market.

Instead, the bulk of home sales are being done through all cash, a sure sign of a pickup in home speculation and investment. Over 50% of all home sales continue to be done through all cash transactions, far greater than any historical periods.

Affordability Weakens, so Banks Reach

Banks are again lending mortgages to under qualified applicants in an effort to make up for the lack of traditional homebuyers and keep their mortgage businesses afloat.

Recently, JP Morgan (NYSE:JPM) announced 2,000 more layoffs in addition to 2013’s 4,000 mortgage department layoffs. They weren’t the only ones as Wells Fargo (NYSE:WFC), AIG (NYSE:AIG), and Bank of America (NYSE:BAC) also joined in laying off large parts of their mortgage departments.

But that hasn’t stopped the banks and lenders from still reaching for borrowers.

According to the AEI’s International Center on Housing Risk, 24% of all mortgage loans are now being offered to candidates with debt to income levels higher than the CFPB’s qualified mortgage rule limit of 43%.

As the Wall Street Journal reports, “New lenders spring up to cater to subprime sector”.

Adding to the risk, over 50% of all home purchase loans now utilize only a 5% down payment, putting banks and lenders again at great risk of a housing market price decline.

The only thing it seems going well for the housing market is the home price inflation driven by investors and the non-traditional home buyer.

But how long will what seems to be a temporary rise in prices driven by investors last?

Housing Stocks

If there is one thing investors and financial theory rely on, it is that the equity markets are forward looking.

Housing stocks (Nasdaq:FSHOX) have performed true to form, anticipating the slowdown in the sector, topping back in May of 2013 while most other sectors and stocks continued to rise to new highs in 2013 and 2014.

(For more on the housing bubble’s eventual bursting, see my other article from February, “have housing stocks topped”.)

The chart below of the Contruction Shares ETF (NYSEARCA:ITB) was provided to our Technical Forecast readers along with commentary showing both a short term long opportunity but also a longer term short trade once prices reach key thresholds and break down through final support levels.

The bearish setup shows that in addition to double topping with May’s high in February, ITB may be forming a bearish head and shoulders pattern as it is close to breaking down from its uptrend.

If it does, just like last May, it will likely be another sign that the housing market is going to continue to get worse as the home builder equity prices (NYSEARCA:XHB) continue to lead the declining housing market fundamentals.

Check out the ETF Profit Strategy Newsletter to see our recent study on the housing market’s speculative fervor and what it means for the sector ETFs tied to it.

The housing recovery is essentially non-existent except in price, and eventually these disconnects will work themselves out, likely with housing prices joining the other fundamentals at lower levels.