With the housing market showing no signs of recovery any time soon it may be time to take a look at some of the stocks in the sector that could be headed lower. While be may have arrived to the party late, I certainly don't think the party's over as the whole group could see continued new lows. Although it's hard to predict where the bottom lies for some of these stocks, I believe they could still see another 15% to 20% drop. As such, if my forecast is right, Lennar ($34.86, down $1.45) could be headed below $30.
Just how bad is the housing market? To start, the sector's biggest problem is the excess of homes on the market, which in turn causes housing prices to fall, sometimes sharply. The high supply of houses is keeping many would be buyers on the sidelines because they are expecting a further drop in prices. Further signs that the housing markets remains in trouble: increased foreclosures and delinquencies, higher adjustable rates, and lower appraisals. FYI, inventory of unsold homes is at its highest level in 15 years! Add it all up and it makes perfect sense that we haven't seen anything yet.
Many of the homebuilders are starting to report earnings are they are atrocious. Lennar posted a second-quarter loss as inventories of unsold homes rose. Talk about Wall Street getting hit by a bus, for the second quarter, losses totaled $244 million, or $1.55/ share, versus a profit of $324 million, or $2.00/ share, in the previous year. Wall Street expected Lennar to post a profit of 5 cents/ share. Needless to say, "the bus" fell way short of expectations. Lennar also warned that it would likely post a loss through at least the third quarter as it may continue to cut prices and offer more incentives to attract "skittish" buyers. My bet is if the company expects a loss in the third quarter, might as well come out and say you expect the fourth quarter to be a loss as well.
Folks, things aren't good but the risk/ reward here is higher than other option trades. I mentioned earlier, this earnings quarter is off to a tough start with some of the stocks recently hitting new 52-week lows. Expect some volatility with the sector which means any option positions that you may take could experience significant price swings on a daily basis. For instance, the sector will be affected by a bevy of financial news concerning interest rates, economic reports, and news about the current supply and demand.
As much fun as it was to watch the rally in the homebuilders over the past few years, I've been looking at the Lennar August 35 puts (LENTG, $1.63, up $0.63) which jumped 63% on Tuesday. Last Thursday they were trading at $1.12 and by Friday they were down to $0.80 as the stock traded above $37. Tuesday they were up nearly 65%. I told you there was volatility. You could wait for a lower entry point or set a limit of $1.75. Again, timing will be tricky as to when we may actually see the bottom for this stock but with downward momentum building, I'm comfortable with with the limit price.
Most analysts on Wall Street still expect builders to be in the black for the year so expect more downgrades and surprises. Negative earnings means negative free cash flow, which can only get uglier at a time when many builders' debt loads are high.
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