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There are not that many easy targets out there for either private investors or portfolio managers, but one of the most obvious is lumbering slowly across the landscape with big concentric circles painted on its side: the exchange traded fund of US housebuilders, called the XHB.

Short selling is not an easy game, but the XHB is a great stock to borrow and sell. At a time when people are trying to devise complex structures to profit from, or avoid losses in, US housing credit, a simple solution such as shorting a basket of vulnerable equities may be among the easiest, most liquid and most profitable.

The XHB has only been around for about a year; it was put out just in time for a visible decline in the prospects for its industry, which began last spring. Interestingly, housebuilder stocks have been in a choppy rally since last summer. There is a saying on Wall Street: do not try to catch a falling knife. Well, there seem to be a lot of amateur knife-catchers these days, who presumably have been hoping for the Federal Reserve, or Chinese bond buyers, or speculative housing investors, to bail the builders out of their overcapacity. It has not happened. However, the buyers of the index have raised the price from $28 and change in mid-July to more than $38 last week. That just gives you, the short seller, more running room on the downside.

There are some positions, such as, say, going long or short oil futures, that have a lot of danger in them. There could be a US attack on Iran, or a US settlement with Iran, that could take any strategy way out of the money and into the world of margin calls and forced liquidations. But the US housing market takes years to move up and years to move down. I am not the first observer to make a negative call on the industry. Now, though, enough evidence has accumulated that the nervous short seller (and all short sellers should be nervous) can be confident the trade will work out.

The housing industry in the US is a consumer business, so you want an opinion from a consumer economist. Susan Sterne of Economic Analysis is, in my view, the dean of consumer economists, and she sees nothing but grey skies and driving rain for the builders. “What is the Fed talking about with this ‘signs of stabilisation’? There are no signs of stabilisation. The problem is that they are spending their time looking at adjusted data, not the nominal data. But at turning points, when you have rapid changing in pricing, the adjusted data don’t pick up on what’s really happening. The last time there was a sector crash, the tech bust of 2000-2001, it also took the central bankers a while to pick up on reality, for the same reason: the gauges were stuck.”

There are problems with the reporting of housing data. New house sales statistics in the US do not pick up cancellations. If a sale is made, then cancelled, it is not taken out of the sales numbers. One large Florida housebuilder supposedly had more cancellations than sales last month. The reporting of foreclosures also apparently lags reality. Part of the problem is that many of the data are collected by trade associations and industry participants who have a naturally bullish outlook and a lot of personal and corporate leverage. Also, the data have to be collected from hundreds of thousands of companies in thousands of jurisdictions. You can find auto sales numbers from a few websites or a handful of phone calls, not so with house sales.

When the housing sector starts to decline, it takes a long time to turn round. The Japanese market was down from 1990 to 2004; the last time the US sector was weak, prices in previously hot markets declined for four years.

This is not to say the housebuilders have to go bust. The entrepreneurs who started these companies, and who still run them, are a hardscrabble lot. They’ve gone from heating canned soup to champagne on a Gulfstream jet, and they can go back to the canned soup if they have to. Some will go bankrupt, but many will not. As Howard Simons, of Arbor Research in Chicago, says: “Most of their inputs are people, equipment and supplies that are supplied just-in-time.
They can manage costs. The
principal inventory is undeveloped land.” A lot of that land is being dumped right now.

While many, or most, of the companies in the XHB index will survive, the shareholders will not have a happy time. Dividends? You must be joking. Last year, some of the housebuilders were optimistic enough to pay out cash for stock buy-backs. I would not expect more of those.

There is a risk to shorting the housebuilders, though: private equity funds. The cash that is eluding the housebuilders is in the accounts of the buy-out brigade, at least for the moment, which makes a short sale of an individual stock a bad idea. That is why it makes more sense to short an index, or, better, an ETF.

At a time when there is not a lot of clear value out there, this is not a bad anti-value.


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