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Words of Caution

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July 24, 2007 – Comments (31)

There's one thing many of the current top ten in CAPS have in common - and that's being very bearish on homebuilders, morgtage lenders, banks, REITS, and pretty much anything and everything related to the downturn in the housing market.

It's a trend that this Fool has largely steered clear of.  Actually, I picked a few homebuilders to outperform some months ago, so while everyone who'd been trying to catch me has been gaining a whole lot of points in the downdraft, I've been losing them.

But I have no complaints.

Sure, looking back, if I were smart and looking to preserve my lead in CAPS, I'd have jumped on that bandwagon too, and it's not hindsight that's making me say that.  The reason I should have from a pure 'game' perspective is that's what everyone who was trying to catch me was doing.  Ever watch a sailing race?  A yacht in the lead will always try to match the moves of those who are trailing.  The reason is that the leader doesn't want to allow the trailer to get a more favorable wind.  By matching the movements of the trailer, the leader helps ensure that they have the same wind, regardless of how good or bad that wind is, so that the lead is preserved.

But I didn't do that, and there's a reason.  I called outperform on a basket of homebuilders (albeit a bit early, perhaps a great deal early if the current trend continues) because despite all the gloom and doom prognostications there is something very, very real supporting the industry.  We all need places to live, and the population keeps growing, steadily.  This doesn't mean that there can't be pain in the sector, but unlike tulip bulbs in the late 16th century or the more recent dotcom crash where the 'new paradigm' was more self-delusion than reality, there is some very real support to housing prices, and there will be an ever continuing need for new homes due to population expansion.

Those that are betting against this 'bubble' are, in my mind, perhaps playing a dangerous game.  It's one thing to bet against pure fluff and hype.  It's quite another to bet against an entire industry that will, absolutely and without doubt, turn back around.

Maybe some who are betting against this sector in such a big way are far better market timers than I'll ever hope to be (not that I really ever try).  Maybe they're right, and I'm wrong (as our relative CAPS performances of late would lead one to believe).  Again, though, when making a big bet against a big sector, I, personally, would want to steer clear of betting against a sector which produces something we cannot live without, and something that we need more and more of every single year.

31 Comments – Post Your Own

#1) On July 24, 2007 at 11:34 AM, nonanolet (79.51) wrote:

I don't argue that people need places to live, but the way that home values have been skyrocketing for at least the last ten or even twenty years leads me to believe that the whole sector is going to take a nice, long snooze.  And thank god because people can't afford homes anymore.  Next thing you know, it's going to be fifty year mortgages at this rate!  I, for one, am really glad to see a slowdown and an end to all the madness.

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#2) On July 24, 2007 at 12:21 PM, EPS100Momentum (71.97) wrote:

Caps is skewed to benefit the people who pick underperform. A stock can gain lets say 12% for the year but if the Market gains 13% you still would be down on the stock by 1 point. So as you see Caps is skewed to the benefit of people who pick underperform. Its alot harder to pick outperform and get 2000+ points then it is to pick underperform and get 2000+ points.

 So saying the economy is going down because underperform picks are winning is not valid. You could have an underperform call winning even when the economy is in full speed ahead, because CAPS gives the advantage to the underperform call.

If you want a pure Contest then the points should be placed evenly at break-even when you bought the stock and not skewed to one side! If that would have been the case I probably would have over 4000 pts and the underperform callers would be knocked out of the top by many others like me. 

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#3) On July 24, 2007 at 12:34 PM, TradingAddiction (< 20) wrote:

Well thats stupid. The caps works both ways. The S&P can easily go down 12% then the bulls benefit. Caps rewards risk takers.

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#4) On July 24, 2007 at 12:51 PM, des52 (< 20) wrote:

For now I'm staying away from the Banks and such because even though I don't think the sky is falling others do.  The market can't decide how to price things right now.  The credit bubble in america may be in trouble but a credit bubble is beginning in the rest of the world.  I'm trying just to be patient and wait.  Keep exposure in 6 good companies with international exposure that are doing great and keep buying as they drop in price.  The market is a winning game in the long run.

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#5) On July 24, 2007 at 1:09 PM, dyoh (< 20) wrote:

Home ownership is the highest its ever been which is changing bacause subprime loan problems and interest rates are rising. These builders will stick around and some will be great companies, but pick them up at a discount in the future, not now.

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#6) On July 24, 2007 at 1:44 PM, EPS100Momentum (71.97) wrote:

lol, your funny AllTimeHi! But your not totally truthful. The truth is the stock market has 7 out of every 10 years as up years historically so like I said CAPS is skewed towards benefiting the Underperform Calls.  whether you like or not, the facts are the facts!

You said the caps system rewards people who take risk? Please tell me how your taking a risk saying underperform? Its pretty much risk free, all you have to do is look for Junk stocks or stocks in a bad sector and pick underperform. Since the market is in a bull market the Average stock will do better than those you just picked as underperform. Even if some of your stocks manage to perform at the market average you still would not lose any points on it. But its alot harder to pick a stock that will outperform the market.  Because it needs to go up  higher than the market average to make any points on it at all.

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#7) On July 24, 2007 at 2:13 PM, TradingAddiction (< 20) wrote:

So you are saying that we will never experience a bear market? 

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#8) On July 24, 2007 at 2:18 PM, fOOLSONPARADE (94.67) wrote:

It is a lot bigger than housing Russell.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a5N1O2zRUVNs&refer=home

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#9) On July 24, 2007 at 2:44 PM, SpecBear (98.92) wrote:

My CAPS strategy is largely based on the lessons I learned during the dotcom bubble.  The current bubble has gotten so much worse because it's actually based on established markets and products that have actual utility to everyone.  It's difficult to make the case that a sector as solid as residential real estate could be in a huge, nation-wide, speculative bubble because such a thing has never happened before.  People are understandably skeptical.

This isn't about market timing.  It's about following the fraud, and there are so many dirty hands in this business it's mind-boggling.

As for CAPS giving the advantage to underperforms, let's looks at the numbers: Fewer than 5% of CAPS players have the Underdog charm. Fewer than 3% have the Bankruptcy charm.  Compare this to the 17% who have the Score Club 100 Charm.  I keep reading the claim that picking junk stocks is easy, but the stats indicate that not many people are doing it well.

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#10) On July 24, 2007 at 4:23 PM, Zanibel17 (97.88) wrote:

Hi, TMFEldrehad.

I agree with foolsonparade on this one.  The Housing/Mortgage Loan industry was the fragile support system of a very unstable house of cards propped up by the Federal Reserve.

There is a bigger story here that has to do with our currency system and how it has been manipulated.  If you want to take the red pill, so to speak, there are a lot of resources out there. Some are wacky, some not so much. 

Not sayin', just sayin'.

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#11) On July 24, 2007 at 4:24 PM, Zanibel17 (97.88) wrote:

Hi, TMFEldrehad.

I agree with foolsonparade on this one.  The Housing/Mortgage Loan industry was the fragile support system of a very unstable house of cards propped up by the Federal Reserve.

There is a bigger story here that has to do with our currency system and how it has been manipulated.  If you want to take the red pill, so to speak, there are a lot of resources out there. Some are wacky, some not so much. 

Not sayin', just sayin'.

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#12) On July 24, 2007 at 5:14 PM, StockSpreadsheet (74.73) wrote:

I agree that the home builders will do well over time.  As you said, people need a place to live.  However, I don't think they will do well for the rest of the year and probably longer.  The subprime and Alt-A mess is going to be dumping a lot of houses on the market due to forclosures.  These new homes will often be sold at firesale prices so that the banks can get them off their books.  (The banks would like the cash and don't want to pay the upkeep on a home for a year or more to keep it in saleable condition until the market turns around.)  With all of the supply that's going to be coming back on the market or be returned to the builders in the instances where they were the ones that made the loans that people can't afford, the home builders are going to have trouble selling any new homes.  This supply problem is going to be acerbated by the tightening of lending standards, keeping many out of the market that would have been looking to buy a new home last year or before.  So you have a large increase in supply and a large decrease in demand, (due to unaffordability or the inability to get a loan).  Prices will go down, profits will go down and thus home builders stocks will go down.  In a year or two, I believe,  then homebuilders will be good stocks to own, but not now.  For now, they will underperform.

 If I was the type of person to make underperform calls, I would mark the whole sector as underperform.  In a year or so, after all the subprime and Alt-A loans have reset and people have had a chance to figure out if they can afford their loans or not, then it would be time to reevaluate the sector to see if it has room to grow again.  That is what I believe and that is what I told my investment club when somebody recently pitched a homebuilder stock as a stock for us to buy.  

My two cents.

Craig 

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#13) On July 24, 2007 at 5:56 PM, seanleckey (99.81) wrote:

In addition to the sectors you mention, many of the new top ten are heavily in oil.

I kept mostly away from both, expecting their overweighting to eventually take its toll like it has to other sector betters. 

Now in the course of a couple weeks I've gone from 4th to 17th and more importantly a huge 1500 point gap to make up.

 

 

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#14) On July 24, 2007 at 8:34 PM, dwot (97.03) wrote:

This isn't just a homebuilder problem, it is also a credit problem to do with low interest rates, and that simply compounds the problem.  Bank will also be squeezed as consumers curb spending because of interest rate increases.

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#15) On July 24, 2007 at 10:44 PM, luvb2b (35.09) wrote:

To Eldrehad and anyone else thinks that house values are "supported" by something... I think this article illustrates nicely that when the market sours support vanishes.

Houses Cheaper Than Cars In Detroit

"A four-bedroom house near the original Motown recording studio sold for $7,000."

Eldrehad, you may catch a short term bottom in the home builders somewhere.  Market history suggests that a bottom won't happen until October.  This one or next.

Between now and then, I'd bet that several of the homebuilders go under and the rest have to take severe markdowns of inventory on their balance sheets.

Good Luck.

Luv

PS I am still gunning for your score. 

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#16) On July 25, 2007 at 9:39 AM, BankerChris (50.23) wrote:

I guess that I'm a CAPS cheater.  I checked out a bunch of Realty and home stocks and picked underperform.  However, that was just to build some points.  It's not like that's not my area of expertise either.  I'm a banker, so by trade I know quite a bit about the financial sector and the housing sector.  Well, let me rephrase... I'm a young, very young banker, and I know alot for my age.  There is still plenty to learn.  However, I do not pick underperform just to get points.  If I had these stocks now I would sell... rebuy when they hit bottom... and hold for a few years... i'll probably be changing alot of my picks in the next few years to outperforms. 

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#17) On July 25, 2007 at 10:37 AM, nonanolet (79.51) wrote:

The reason I go long on everything is because I use Caps as a giant watchlist for my real life investing activities and in real life I do not short stock.  Caps is much more than a game to me.

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#18) On July 25, 2007 at 10:42 AM, TMFEldrehad (99.99) wrote:

Houses selling for less than cars?  That's exactly the kind of FUD (Fear, Uncertainty, and Doubt) that I'm sticking my neck out to bet against.

You can talk about lack of "support" as evidenced by what a few forclosed properties are selling at auction in one of the most economically depressed sections of Detroit if you choose, but the truth is there is support.

Houses have utility.  They are useful things that we all need, and that isn't going to change.  Just as markets can price things irrationally on the high side, they can just as easily be priced irrationally on the low side - as some of those houses in Detroit clearly are.

Some homebuilders go under?  I'm not denying the distinct possibility.  The rest taking severe markdowns?  We've already seen quite a bit of this, and I there's a very good chance we're not done yet.

That said, there is an underlying product here - one that is very useful, one that we all need, and one that we need more and more of as our population continues to increase.

Have we hit the bottom?  I have no clue, but there's a good chance we haven't.

Why am I then making my CAPS calls now?  Because by the time most folks realize the bottom has occurred, the recovery will have already been well underway and a great deal of the returns will have already been realized.

Is there a good chance you are right and I am wrong?  You betcha!  That's what's great about CAPS though.  We both get to record our opinions on record, make our calls, and when the dust settles, see who's right - and most importantly, perhaps learn something in the process.

Fool on!

Russell (a.k.a. TMFEldrehad)

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#19) On July 25, 2007 at 8:04 PM, jademonki (< 20) wrote:

How is CAPS and the underperform choice unfair ?  Can't we all pick underperform on all the same stocks ?  YES !

 so if a CAPS player takes advantage of calling a whole sector underperform and racks up points and you don't... how is that their fault?

I see no foul.

.

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#20) On July 25, 2007 at 11:47 PM, luvb2b (35.09) wrote:

Eldrehad, I agree with your ideal of picking a bottom.  Generally speaking you want to buy when others are selling or avoiding the sector.

As far as the idea that a useful product correlating with a stock that has value, one has to look no further than the airlines to know that isn't true.  Over the past six years we've watched one airline after another racing to bankruptcy despite all of them selling a product that is needed all over the world.

The reason I am urging caution in the case of the homebuilders is that besides the numerous markdowns that have yet to occur, I believe there are also credit ratings that need to be cut (increasing cost of debt for these companies).  I believe a lot of these builders are going to be facing recourse for some of the loans they made.  I also believe that the cycle here will be 3-4 years, not 6 quarters which is where we are from the peak.

Good luck with your picks, I hope you got these wrong enough so I can finally catch up to your score. :)

Luv.

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#21) On July 26, 2007 at 1:48 AM, dwot (97.03) wrote:

 I saw the article below today. 

http://money.cnn.com/2007/07/25/real_estate/prime_catching_subprime_ills/index.htm?section=money_topstories

 My young adult years were right after a housing bust and I saw so many with their houses gone and owing debt and down payments gone.  Our BC economy is about 1% of the size of the US.  We had a huge recession following it.  All of our smaller banks and credit unions merged and disappeared.

Now this is happening in an economy 100 times bigger under far worse conditions.  Everyone will know someone very hurt by this whole thing, and that makes buyers wait.

I think you are missing the depth of this problem.  Something else I was reading, I think Florida has about 6 extra years of supply in some areas.

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#22) On July 26, 2007 at 2:07 AM, infoLust (28.57) wrote:

Reduced barriers via the sub-prime guise created demand which shouldn't have existed in the first place.  The problem compounds twofold:

a) inflated prices due to artificial demand - the pool of potential borrowers increased dramatically.

b) inflated interest rates marginal borrowers had to bare due to the credit risk - the additional interest created the risk.

It is obvious that increasing the interest rate to offset default risk is unstable.

So home builders are now competing against a flood of foreclosures in addition to a decline in demand and prices.... another downward spiral.

If Countrywide says the worst isn't over until  2009, i don't think now is the time to go long.

But now that you've posted your position it becomes more difficult for you to change your position in light of new information - what most people call waffling.

The truth is that population growth in the US in 2007 is rather small - a mere 0.894%. - not a major driver for the near term.

So I am short home builders and subprime and will continue to be for quite a while.

The funny thing about our market right now is that there is a simultaneous bull and bear going on.

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#23) On July 26, 2007 at 7:47 AM, cobradon (99.25) wrote:

All's fair in Love, war And CAPS... This is just a game! A game where the rules favor no-one. We all have the same options. (no pun intended)

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#24) On July 26, 2007 at 9:35 AM, TMFEldrehad (99.99) wrote:

At least a couple of you seem to have misunderstood the point I'm trying to make (likely my fault for not making it clear enough).

I want to make it perfectly clear that I'm not complaining about the rules, or anything else.  I have congratulated the new Top Fools personally, and think they've done a fine job.

It's just that with nearly everyone on the top ten list calling underperform on homebuilders and related companies, I thought I'd share with the CAPS community my reasoning as to why I haven't.  That was the point of my blog.

Regards,

Russell (a.k.a. TMFEldrehad)

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#25) On July 26, 2007 at 1:48 PM, Zikar (54.64) wrote:

You hit the nail on the head. Of course, traders and investors often don't understand each other, and anything to bring the two together should be helpful.

I agree with your call on the housing market, it has and will be oversold to the point of madness, thanks to the panicky herd mentality I see sometimes. One just has to be willing to take massive amounts of pain, because there is no telling when this will actually end.

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#26) On July 26, 2007 at 2:18 PM, nonanolet (79.51) wrote:

I'm going to temper what I said in the first comment to this post and qualify that if the real estate slowdown becomes so bad that it triggers a recession, then it's not a good thing.  But it's too late now, the die is cast.

When people with good credit take out second mortgages in order to buy "investment" properties at the tail end of a runup that lasts several decades, maybe they deserve to lose their shirt.  Then again, maybe I'm just getting worried that this whole thing is going to blow up in our face. 

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#27) On July 26, 2007 at 7:03 PM, MKArch (99.71) wrote:

Russell,

 

Good blog, I've been taking a TMF1000 type approach to the home builders and related stocks, add one when they tank some more add another, countrywide tanks add them too. I may not be able to average down on a specific company but I can sure average down on the industry.  It's a little tough knowing you are likely screwing up your short term ratings but I'm fairly confident this will pay off handsomely in the next few years.  When the urge to protect my current ratings kicks in I remember back to the companies I wish I had enough gumption to buy way back when.

 

Mike

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#28) On July 26, 2007 at 10:56 PM, infoLust (28.57) wrote:

If you're going bottom fishing it is better to wait until earnings reports reflect recovery.  We are still riding the bubble down.


 

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#29) On July 29, 2007 at 1:41 PM, relzsek (29.97) wrote:

InfoLust, I disagree with that statement. History shows clearly that stock price typically anticipates the actual earnings improvement. If you wait for earnings repports to confirm recovery, you will miss half of the profit potential in stocks depressed by fear as much as fundamentals. It is true that bottom-fishing can be treacherous and nobody can be sure of the bottom, but I prefer to start to nibble when my analysis suggests that the downside is limited and all the bad news is baked in. My wiew is that the panic is overdone. Yes, housing got ahead of itself, that is plainly obvious and the subprime mess is painful, but continued population growth, limited land availability, historically low interest rates and continued economic growth will stabilize the housing sector soon. There is plenty of liquidity in the system and the shear size of the US economy will absorb this abberation. For all of you still red-thumbing homebuilders, remember that the large short interest represents a large pool of obligarory buyers of these stocks....

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#30) On July 30, 2007 at 12:33 AM, infoLust (28.57) wrote:

a short squeeze is hardly anything I can consider sustainable investing.  Though if I had enough time on my hands and enough money, I would write a automated trading system to detect short squeezes and profit handsomely.

This situation is quite different because the mathematics behind the variables involved amplify one another.  You will know when to go bottom fish because you won't need a fishing pole.

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#31) On July 30, 2007 at 1:04 PM, BankerChris (50.23) wrote:

I look up to the more mature and experienced CAPS players alot and have really enjoyed reading everyones input on this subject and have developed my own ideas based upon some of the arguments provided.  I guess THAT is what is so great about CAPS.  Red thumb or Green Thumb it's still Investors helping investors beat the market.  Thanks to everyone!!

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