Monday, January 15, 2007

Housing Battle

To Go Long Or To Go Short

Bill Miller, the famed-Legg Mason fund manager, was on television last week saying he is long housing stocks. In Barron's Up & Down column, Doug Kass of Seabreeze Partners was cited as being short the stocks--no big surprise there.

Kass referred to order cancellation as the reasoning for his bearishness. Typically, publicly traded homebuilders have cancellation rates of 15% of orders; however, that has jumped considerably.

Cancellation rates of publicly traded homebuilders:

Centex -- 37%
DR Horton -- 40%
KB Homes -- 53%
Lennar -- 31%
Pulite Homes -- 36%
Beazer -- 57%
Hovnanian -- 35%
MDC Holdings --49%
Standard Pacific -- 50%

These numbers are all provided by Kass, according to the Barron's article. These numbers are so bad that the worst might be unfolding right now.

TheFly's advice, Miller tends to be too early and Kass is often too negative when the worst is already priced in the stocks. Start following these stocks again, expecting a bottom in the spring and early summer.

The most recent rally is mostly from an oversold condition. Wait for another correction and see where the industry fundamentals stand.

Stock Shrinkage

Stock Outstanding Shrinks By 3%

In 2006, between private equity and share repurchases by US corporations, the amount of stock outstanding declined by a good chunk in 2006.

In a newsletter released this morning by investment strategist and portfolio Don Hays of Hays Advisory, there was $400 billion in cash takeovers this year by private equity and corporate mergers and acquisitions. In addition, there was over $600 billion of share repurchases.

This adds up to 3% shrinkage in the supply of stock available for purchase.There could be a lot more of this in 2007 as a whole host of US companies are generating a lot of excess cash that management will need to put to work. Home Depot (HD) is the poster-child stock for excess cash generation and share buybacks.

A good investment approach for 2007 might be to find companies like Home Depot with little debt that generates a lot of free cash flow and can afford big stock buy backs. Sooner or later demand will outstrip supply and drive stocks with these characteristics higher.