Summary
- The homebuilders jumped after Powell’s dovish Fed meeting.
- NAIL, a 3x leveraged ETF, could be an effective short-term trade on the sector over the next month, as inventory remains limited but better affordability returns this Spring.
- Having broken up beyond its 50-day in early January, the ETF's next technical challenge is its 200-day at $55.18.
The US home builders had a terrible year in 2022, obliterated by the sprint in interest rates, a choke-off in affordability, and the general sense that a lot of purchasing had been "pulled forward" by pandemic nesting and the urban exodus of 2021.
Hope springs eternal, however, especially when Powell is conciliatory, and the home builders saw an enormous spike immediately following the Fed meeting. On Monday, February looked like the depths of winter; now it suddenly looks like the perfect month to get a jump on early home buying. Market sentiment is funny like that.
The Trade:
Whether the momentum is truly durable or not, the Direxion Daily Homebuilders & Supplies Bull 3x Shares ETF ( NAIL ) might be an effective way to engage this sector short-term. The ETF seeks to triple the daily performance of its benchmark -the Dow Jones US Select Home Construction Index - before fees and expenses. This index measures the U.S. home construction sector, a wide swath of companies (large cap to small cap) that provide the products and services related to homebuilding, home improvement retailers, and building material suppliers. Names include core builders like PulteGroup (PHM), stalwarts like Home Depot (HD), and paint companies like Sherwin-Williams (SHW).
NAIL ETF Holdings (Jan 30, 2023) (Schwab)
The Argument:
Maybe There's No "Minsky Moment" in Housing This Time
When it comes to real estate, most of us have the recency bias of the Global Financial Crisis of 2008. We expect a long multi-year drop in home prices, with the sector off limits for another two years. But, arguably, a few things are different. Unlike 2007 and 2008, we did not - and probably will not - experience a real estate-induced banking crisis. In fact, US banks remain strong, thanks to stress tests instituted in 2009.
The generational and inventory mix is also more favorable this time, with a larger demographic cohort of homebuyers - Millennials instead of Gen X - and far less inventory. Remember: the liquidity and collateral crises in the US in 2007 and 2008 were real estate-centric; even the most esteemed banks were pushing NINJA loans and blithely pumping out CDOs based on a questionable Gaussian copula function lifted from actuarial science.
Yes, affordability is shockingly lower than it was just 12 months ago, but the lending system is not broken - and banks as operative mechanisms are functionally intact. The argument for a resilient homebuilders sector is that, if inflation cools, and employment softens but doesn't collapse, then home prices might drift lower but not actually swoon. This would be due to:
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limited inventory, and
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a Millennial generation (i.e. the ones with the richest parents in US history) which will continue to buy homes due to "time of life" / family formation considerations.
The US real estate sector has certainly seen a lot of pain lately. In December, existing US home sales were down 1.5% from November, marking the 11th straight month of falls. Believe it or not, this is the longest stretch of month-over-months negatives since 1999 , as "late to the party" buyers, faced steepening prices and mortgage rates, hit the pause button.
Existing US Home Sales (Month over Month) (Tradingeeconomics.com)
But therein lies the rub. The buyer's strike (or affordability choke-off) is approaching a year, and we don't see distressed selling. Unlike 2008, sellers had the discretion to take their properties off the market.
One reason perhaps: at the national level, the supply of existing homes available for sale is still historically low. Remember, a 6 month home supply is traditionally needed to balance supply and demand in the US system:
Existing Homes --Inventory (Numernomics.com)
During the years of the Financial Crisis, the US saw on average a 9-11 month supply. With many homes handed back to the lenders--remember " jingle mail " - home prices collapsed as banks sold them off.
Contrast that to today's market: we see 2.85 months in the present supply of homes on the market. Reduced supply today may prevent prices from falling more rapidly, swamping the system and scalding the comps. Also: that "no income / no job / no down payment" buyer never existed in the recent market. Lending standards are much higher today and most recent buyers needed down payments. They have skin in the game.
Of course, the pandemic got people over-investing in their homes. Dirt cheap home loans allowed for patio build-outs for all that private "socially distanced" entertaining; and even zoom room rehabs proliferated as people worked from home. The investment might have pumped up the revenues at Home Depot and Lowe's (LOW), but I don't think it will cause 2008-level financial distress (due primarily to the low interest rates and unnatural level of savings that US consumers enjoyed during the Pandemic). I have heard many "Before the Fall" arguments that the consumer is working down their savings and that this summer will be the reckoning, but though they are substantive, they are not preordained.
With significantly lower inflation, minor job cuts, and better affordability, the housing market might do a softish, tuck-and-roll landing (rather than the Humpty Dumpty face plant of 2009).
Affordability's "Green Shoots":
In November, the housing affordability index was 95.5, leaving potential buyers with 4.5% less income than necessary to buy a median-priced home. That is well-off the historic January 2021 peak of 183. But if normalcy returns, Spring 2023 could provide a more humble trifecta: mortgage rates dropping slightly; consumer income rising vis a vis diminished inflation; and home prices declining steadily. This could give the affordability index a jolt upwards above 110 during the year.
First time home buyers were the ones getting priced out in 2022, but that might mitigate this Spring. Falling home prices and lower mortgage rates may help. According to economist Steve Slifer , by March 2023 the down payment on a median-priced home will have fallen from a peak of $84,000 to $70,000. The monthly payment should have shrunk from a high of $2,000 per month to $1,775.
Down payment and monthly payment Required (sslifer, Jan.31 Numernomics.com)
Of course the home builders have already risen from their October lows. That's why NAIL might be the way to catch more of the late upside. It broke out beyond its 50 day in January and seems poised to stab at its 200 day ($55.18) within the week.
This is a technical challenge, but it will be helped if mortgages drift lower. A recent Freddie Mac survey reported that the average rate on a 30-year fixed mortgage decreased to 6.13% as of January 26th 2023, down from 6.15% in the previous week. According to Freddie Mac chief economist Sam Khater :
"Mortgage rates continue to tick down and, as a result, home purchase demand is thawing from the months-long freeze that gripped the housing market.... Potential homebuyers remain sensitive to changes in mortgage rates, but ample demand remains, fueled by first-time homebuyers."
Mortgage Rates (November to late January) (Tradingeconomics.com)
What is clear: sellers will not have the upper hand they enjoyed in 2021 or early 2022. They might be using more drone photography , Matterport VR, or Windtunnel renderings to lure non-local buyers; they may be baking cookies before each opening (like my brother- in-law famously did to great success in 2007).
The Spring 2023 home buying season will be far more sober, but that just might work for the homebuilders.
Big Risks and Technical Challenge:
Of course as a 3X leveraged ETF, NAIL applies a lot of leverage to try to gain that 3 times daily return. Because of their unique construction, leveraged ETFs are only intended for tactical use over very short holding periods - such as intraday or a few days. Why? Because leveraged ETFs are known for their natural decay. Holding a position in a 3x leveraged ETF will be worse than holding an 3x leveraged position in the underlying asset because - due to a multi-day tracking inefficiency called " beta-slippage " - the 3x ETF's value tends to decay even when their underlying index is favorable.
Another caveat: NAIL has raced from its October low, breaking through its 50 day MA January 7, and is now approaching its 200 day of $55.18. This sprint could suggest that the 200 day will become a serious resistance line. This will become clearer Monday, as the markets digest this week's rather contradictory news flow. Only strike when you have the right technical set-up and signal. With 3x leveraged funds, timing is everything.
To paraphrase Peter, Paul and Mary: you'll need a hammer and you'll need a bell when trading NAIL.
For further details see:
NAIL ETF: Capturing The New Found Enthusiasm For The Homebuilders