In most of my Housing Market Reviews this year, I chronicled the growing warning signs in the housing market and the on-going technical damage in the stocks of home builders. Until the last few months, I remained hopeful that a turn-around waited around the corner; I kept looking for the reassurances of the home builders to translate into renewed buying interest. I took advantage of the October sell-off to launch the seasonal trade right into the teeth of the worsening technicals and fundamentals. Last week’s earnings warning from KB Home (KBH) may have prematurely ended the prospects of a good seasonal run. If so, this letdown would be yet one more in a long line of disappointments.
Market skepticism has been high for the most of the year. One big warning sign came when KBH raised guidance in April and investors still faded the stock. In January, 2016 and before that in January, 2015, disappointing results from KBH took down the stock and the sector. In the midst of the January, 2016 selling I recommended buying KBH (and other home builders) as contrary bets against the recession the market seemed eager to front-run. That call worked out extremely well. This time around, I am not recommending a contrarian bet (without technical confirmation) because KBH’s earnings warning gave me serious concerns.
Basically, KBH acknowledged a slowdown in the housing market. The warning brought an immediate flashback to August’s warning from Redfin (RDFN) of a market slowdown. The warning took a day to register losses in home builder stocks, but they rebounded. A true breakdown took another month to happen.
Management used the term “slowdown” and allowed analysts on the conference call to freely throw that term around. The final warning that forced the company to reduce guidance was a quarter-to-date (the first 10 weeks of Q4) 14% year-over-year drop in net orders. KBH explained that this drop came from a reduced community count, deferred orders, and a longer decision-making process for consumers as they “absorb” and “digest” higher prices and higher mortgage rates. KBH is also facing competitive pressures as other builders increase incentives. KBH is mainly responding to this slowdown by focusing on selling lower-cost homes as it pushes an increase in community count. KBH expects this change in focus to increase its pool of buyers without inviting an expanded pool of competition (quite a balancing act!). The company even reduced square footage plans in existing communities.
