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Tuesday, January 16, 2007

They Shot A Rocket In The Sky....

Granted, Russia wants the money for the anti-aircraft missiles it is selling to Iran. If you look at the closing to yesterday's post, however, a secondary motive might exist. Iran is the most likely candidate to jack up crude oil prices this year, and Russia's deliveries are declining so it desperately needs those high prices. It's not going to make it up on volume! Coincidentally, Iran also needs those high oil prices.

Crude seems to be going lower. OPEC (Saudi) commented that it had no plans for an emergency meeting.

In other news, Centex predicted a net loss of $2.00 a share for the quarter ending in December. Net sales dropped 24% year over year. It's interesting that everyone keeps talking about a stabilizing housing market while the situation of these homebuilding firms keeps getting worse and worse.

David of Photon Courier recently wrote of his surprise in learning that the New Home Sale index was quite distorted by the way the index is compiled. Sales are recorded when the contract is signed, but cancellations aren't reported. With cancellation rates running an average of at least double the historical norm, this produces a sizeable overstatement for new home sales. The overestimate may be much greater than the guess of 20% cited in the article to which he links.

Consider a homebuilder with 400 houses in all stages of construction from pulled permit to move-in ready at the beginning of the year and pretend that the homebuilder is only building out the current inventory (i.e., no net product added to inventory through the course of the year, even though the homebuilder continues to build on homes not yet completed or even started). In the first quarter, they record 100 sales. Of those 35 fall through. Reported sales = 100, reported inventory = 300. Actual sales = 65 and actual inventory = 335. In the second quarter, closed contracts = 70, of which 30 fall through. Of those 70 sales, 15 are houses that were previously under contract. Those will not be reported sales, but the other 55 sales will be. So now the Census Bureau has inventory of 300 - 55 or 245 and the actual inventory is (gasp) 335 - 40 or 295 ... You can see how the error accumulates over time in a market such as this. Here's the Census Bureau's explanation to prove I am not making this up. They track from permit on, and they drop the permit after it has been reported as being sold once. The homebuilder, however, does not have that option!

There's another very obvious implication, and that is that the sale prices for new homes are overstated as well. In order to curb cancellations, many of the new homebuilders are now negotiating with buyers who want to cancel. For instance, if the buyer has to drop their old home's price by $40,000 in order to sell it, the builder will often agree to drop the new home price by at least half of that in order to close the sale, but this is not picked up in the data. Given the incentives, interest rate buydowns, etc, those contract prices were overstated already, but failing to correct for post-signing modifications introduces another level of overstatement. So both contract pricing and sales/inventory as reported in the New Home Sales report is quite unreliable at this point. Eventually this situation will correct itself, but for now these figures are not comparable to those of even 2 years ago. This is why I haven't been writing much on these releases.

I do laugh hard when I read news articles announcing that the housing market is stabilizing based on a reported marginal increase in new home sales. They cannot possibly know that from the data. It's likely that cancellations will drop somewhat, but the offsetting factor is that contract pricing will be more overreported. After you have signed a contract on the same home multiple times in one year, it's likely that you are going to fight pretty hard to get the contract through a closing. Next year some of these homebuilders will be hit hard in the pocketbook by those incentives that helped them sell this year.

We will know when the new home market is stabilizing by looking at the quarterly financials of the homebuilders. It's unlikely that we will know before those start stabilizing that the new home market is correcting. Another indication of recovery would be four months running in which the completed homes for sale total didn't rise on Census Bureau reporting. We haven't seen one month yet. Remember, there are a lot more completed homes for sale not shown on the report because of the failure to pick up cancellations!

As for months of inventory, obviously if sales are over-reported and inventory is under-reported it is greater than the 6.3 months shown on the latest report. Real inventory could be 8 or 9 months. It's certainly over 7 months given the reported cancellation rates by major homebuilders.

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