2006 was marked by a nation-wide housing slump. Sales were down, and the Y-o-Y price comparison followed suit. A weak housing sector is painful to many parties of the economy: the homebuilders, the realtors, the construction workers, the homeowners who maxed out their home equity line of credit. The worst off among them in 2006 were probably the home builders. To reduce the inventory build-up, they often slashed prices by double digits. Their profits plummeted, so did their stock prices.
Under these dark clouds, it is natural for people to look for a silver lining, no matter how faint it is. For example, a month ago, the CEO of Toll Brothers (TOL, Financial) Robert Toll said that the market for new homes might finally be leveling off after more than a year’s worth of declines (see article). Is this the first light of a housing recovery, or just a head-fake of the market, a dead cat’s bounce, that will lead to a further decline?
I believe Mr. Toll’s observation may be right. After all, he knows about home building more than almost anybody else. But in my view a bottoming of the new home market does not signal the bottoming of the entire housing market. In fact it is expected in a falling housing market.
I have this analogy to the current housing situation: imagine a big crowd gathering on the top of a multi-level building. The top floor was such a prime spot that everybody and his mom wanted to be there. The crowd grew so large that the floor couldn’t sustain it. Some part of the crowd felt the subtle giving-away of the floor and reacted quickly. They took whichever way they could and escaped to a lower level very shortly. These people are the homebuilders. To them unsold homes are inventories that need to be converted to cash as fast as possible. They don’t hesitate to slash the price as long as their inventories can be sold. The rest of the people are home owners and investors. To them their homes are either part of their life, or their high hope to financial nirvana. They relished their top-floor view and were slow to recognize the sinking underneath their feet. We saw that sharp contrast between home owners and home builders in 2006, as many new homes were selling far below the asking price of similarly equiped existing homes.
After the fast responders (a.k.a. the homebuilders) got down to the lower level, they felt the solidness of the floor underneath. They gave out a sigh: whew! I finally felt the bottom. They were right, but that was not the end. Eventually people on the top level felt the floor was sinking unmistakenly. Reluctantly, and slowly, they moved down to the lower level. This is when the existing home price started to drop, slowly approaching the level new homes had experienced.
The question is , are we sure the lower level could hold the same crowd that sank the top level? I think not. The lower level was only 10 to 15% lower than the top level. It was still lofty and unsustainable. It might hold out for a short while, but the law of gravity would eventually force the crowd to seek refuge at an even lower level, a level with more support. The fundamentals that caused the housing market to trend down has not changed. That is why I don’t see much support at the current “bottom”, and another 10 to 15% drop may still be ahead of us.
Under these dark clouds, it is natural for people to look for a silver lining, no matter how faint it is. For example, a month ago, the CEO of Toll Brothers (TOL, Financial) Robert Toll said that the market for new homes might finally be leveling off after more than a year’s worth of declines (see article). Is this the first light of a housing recovery, or just a head-fake of the market, a dead cat’s bounce, that will lead to a further decline?
I believe Mr. Toll’s observation may be right. After all, he knows about home building more than almost anybody else. But in my view a bottoming of the new home market does not signal the bottoming of the entire housing market. In fact it is expected in a falling housing market.
I have this analogy to the current housing situation: imagine a big crowd gathering on the top of a multi-level building. The top floor was such a prime spot that everybody and his mom wanted to be there. The crowd grew so large that the floor couldn’t sustain it. Some part of the crowd felt the subtle giving-away of the floor and reacted quickly. They took whichever way they could and escaped to a lower level very shortly. These people are the homebuilders. To them unsold homes are inventories that need to be converted to cash as fast as possible. They don’t hesitate to slash the price as long as their inventories can be sold. The rest of the people are home owners and investors. To them their homes are either part of their life, or their high hope to financial nirvana. They relished their top-floor view and were slow to recognize the sinking underneath their feet. We saw that sharp contrast between home owners and home builders in 2006, as many new homes were selling far below the asking price of similarly equiped existing homes.
After the fast responders (a.k.a. the homebuilders) got down to the lower level, they felt the solidness of the floor underneath. They gave out a sigh: whew! I finally felt the bottom. They were right, but that was not the end. Eventually people on the top level felt the floor was sinking unmistakenly. Reluctantly, and slowly, they moved down to the lower level. This is when the existing home price started to drop, slowly approaching the level new homes had experienced.
The question is , are we sure the lower level could hold the same crowd that sank the top level? I think not. The lower level was only 10 to 15% lower than the top level. It was still lofty and unsustainable. It might hold out for a short while, but the law of gravity would eventually force the crowd to seek refuge at an even lower level, a level with more support. The fundamentals that caused the housing market to trend down has not changed. That is why I don’t see much support at the current “bottom”, and another 10 to 15% drop may still be ahead of us.
