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A Contrarian View on Housing

Christopher Barker
September 23, 2009

You might not enjoy walking a mile in my shoes.

No matter which direction I go, however, I cannot walk away from my own perception that the worst of the financial crises is not yet behind us.

Although my expectations for prolonged impairment of the housing and construction sectors have not wavered, the prevailing sentiment of investors has turned from panic to confidence faster than I ever imagined possible under the circumstances.

Construction-related equities surged mightily last week. Shares of wallboard manufacturer USG (NYSE: USG  ) spiked 31% higher before settling for a 17% weekly surge. It appears investors are undeterred by USG's looming closure of 30 additional distribution centers. Mexico's Cemex (NYSE: CX  ) tacked on more than 16% before surrendering most of the gains after the weekend. Homebuilders like Pulte Homes (NYSE: PHM  ) moved in the same direction, albeit to a lesser degree.

The building blocks of recovery
Fueling this triumphant burst of optimism, data on U.S. housing starts released last week recorded another month of gains in August to a seasonally adjusted annualized rate of 598,000 units. At less than half the construction activity from a decade ago, we're not yet approaching any semblance of normalcy in the sector, but the ongoing string of sequential improvements marks a welcome bounce from the scariest levels reported earlier in the year.

Treasury Secretary Timothy Geithner then confirmed rumors last Thursday that the administration may extend the November deadline for the $8,000 tax credit for first-time homebuyers. Some 1.4 million taxpayers have applied for the credit thus far -- representing $11.2 billion in total incentives -- though one trade group estimates that only 350,000 of those transactions would not have occurred without it.

The industry fears an abrupt end to recovery momentum if the incentives are withdrawn, and is lobbying to extend the program through 2010 and expand it to all buyers, not just first-time buyers. If these requests are met even in part, we can expect some continued strength in related equities.

JP Morgan analyst Michael Rehaut may be counting on such an extension. The analyst lifted his homebuilding sector outlook Friday from negative to positive, and issued overweight ratings on builders Toll Brothers (NYSE: TOL  ) and KB Home (NYSE: KBH  ) . Rehaut believes the sector is "solidly past its trough," and sees "further upside to the current rally" over the next two years after a potentially bumpy start. I sure hope he's right, but unfortunately I continue to track a wide range of issues that present sweeping obstacles to continued momentum in the residential housing sector.

Cracks in the foundation
While the tax credit program has stoked demand the way Cash for Clunkers did for autos, another government program aimed at stemming the devastating tide of foreclosures has thus far had little impact. The $75 billion effort under way to promote renegotiations of troubled mortgages to stave off foreclosures is not having the desired effect. As