Daily Gains Letter

How to Safeguard Your Portfolio from the Coming Housing Crisis

By for Daily Gains Letter |

Housing Market Fragile Despite Above-Average Potential HomebuildersThe housing market has enjoyed a boom that’s lasted several years as prices have ratcheted upward toward the 2008 highs, prior to the subprime mortgage meltdown. Now, while the housing market has been fairly steady with above-average price appreciation potential in homebuilder stocks, I still think we could be headed for some issues on the horizon.

Some would argue that the housing market is coming off a strong April, with the housing starts reading at 1.07 billion, well above the consensus 975,000 and the 947,000 in March. Building permits, which are an indicator of demand down the road, were also strong at 1.08 billion, compared to the 1.0 billion consensus estimate and March’s 990,000.

While the readings look pretty good, a deeper look into the housing market suggests we could be headed for a housing crisis down the road. Mortgage rates are rising, which is affecting demand in the housing market. Higher mortgage rates also hurt those looking to renew their mortgages, especially those who are already really tight with payments.

The Federal Reserve created an artificial marketplace of low mortgage rates by buying bonds and mortgages over the past few years, but that is, of course, changing, as the central bank moves towards eliminating all of its monthly bond purchases. The result will be higher mortgage rates in the housing market down the road, especially as interest rates begin to rise in 2015. Trust me when I say that this will hurt the housing market.

A report by real estate firm Zillow is foreshadowing the potential problems to come in the housing market. According to the company, the so-called “national negative equity rate” came in at 18.8% in the first quarter, which is better than the 19.4% at the end of 2013 and the whopping 31.4% in 2012; nonetheless, 19.4% is a worrisome reading. (Source: “Affordable Homes Three Times More Likely to be Underwater than Expensive Homes Zillow Negative Equity Report,” Zillow, Inc. web site, May 20, 2014.) This implies that about 9.7 million homes have outstanding mortgages greater than the value of the home. And to make matters worse, Zillow says that about 30.2% of the homes in the bottom tier based on home prices are underwater.

The information from Zillow is concerning; it suggests the housing market could be in a whole heap of trouble as mortgage rates and interest rates rise.

Homebuilders realize this. The NAHB Housing Market Index continues to be weak, with a reading of 45 in May, well below the healthy reading of 80.

Now I’m not calling for a housing market Armageddon; but there are definitely some red flags emerging that could spell trouble for the housing market down the road.

With this in mind, as I have discussed in these pages before, you could play the home supplies companies, such as The Home Depot, Inc. (NYSE/HD) and small-cap Builders FirstSource, Inc. (NASDAQ/BLDR). To play a potential setback in housing, you could also consider buying put options on an exchange-traded fund (ETF) like SPDR S&P Homebuilders ETF (NYSEArca/XHB).

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