In case you missed it, a foreign company nobody had ever heard of until recently staged a gigantic IPO this past week. But lost in all the hype and hoopla was a much more important development here at home: the beginning of the end of the US real estate slump.
New-home sales in the U.S. surged in August to the highest level in more than six years, a sign that the housing recovery is making progress.
Purchases of new houses jumped 18 percent to a 504,000 annualized pace, the strongest since May 2008 and surpassing the highest forecast in a Bloomberg survey of economists, Commerce Department figures showed today in Washington. The one-month increase was the biggest since January 1992.
The oldest adage in the investment game is, of course, “Buy low, sell high.” The second-oldest is, “Don’t fight the Fed.” And with the August housing numbers, the Federal Reserve’s monomaniacal six-year campaign to reconstruct the real estate sector from the ashes of the subprime catastrophe is finally starting to show results. At the same time, the stocks of major homebuilders like Pulte, KB Home and DR Horton are all down YTD.
Hear that knocking? That’s a little visitor named opportunity.
Homebuilding creates a sizable amount of jobs and economic activity, so it’s no wonder the Fed would want to use its considerable powers to bring back the good old days of 2004 and 2005, when builders were slapping up two million new homes a year or so. Rising home prices, like rising stock prices, also induce homeowners to open their wallets and purchase consumer items like cars, vacations, and other discretionary goodies. That’s why the Fed has been doing all it can to keep interest rates at or near zero to entice more buyers into the market. The strategy has had mixed results at best. It’s kept the real estate industry from collapsing again, but it’s also punished savers and created weird conditions in our capital markets. Cash-rich companies like Apple have used the Fed’s free money policy to fund stock buybacks with low-interest bond issues and troubled companies have escaped failure by refinancing what should have been fatal debt obligations for next to nothing.
August’s housing spike will definitely please policymakers. But make no mistake–the new normal of low-to-no interest rates is not going to end anytime soon. Until home prices go up a lot more across all regions and across all price points, the Fed’s efforts will continue. So how can we investors profit on them? The easiest way to play this trend is to buy a house and, if possible, buy a few more. But if that is outside your reach, buy the stocks of entry level homebuilders like DR Horton or–my personal favorite–LGI Homes. They’re almost certainly going to rise as they benefit from our government’s actions. As I said, housing stocks have struggled year-to-date because new home sales and new home starts have barely improved, despite the huge amount of monetary stimulus. But the Fed won’t stop until these metrics get better, which will lead to higher revenues and earnings.
Of course, you could always stay away from boring, brick-and-mortar businesses like homebuilders and put your money into a Chinese e-commerce company nobody knew existed two months ago or another trendy area like social media instead. After all, stocks like Yelp, Zillow, and even Twitter have all shot up in recent months. But these rallies are also a side-effect of the Fed’s low interest rate campaign, as investors chase returns by plowing assets into one hot sector after another. And if you care about old fashioned metrics like revenues and long-term profitability, real estate is much better bet. Consider this: if you back out the non-cash charge for Twitter’s stock option grants to its employees, all of the company’s “non GAAP” earnings would be wiped out. Think about that for a second. That’s not just dilutive, that’s destructive. And when Twitter’s inevitable meltdown occurs, the Fed isn’t going to come to its rescue.