Prior to the 2007 crash, very few investors thought that housing prices could fall, and even fewer believed that a decline in housing prices could be as long in duration or vicious in price as they’ve turned out to be. The silver lining to that cloud is that the crash brought the homebuilding shares down about 90 percent from peak to trough. In our opinion, that opened up a pocket of value at a time when there aren’t many fat pitches in the investment universe. Since we’re always on the hunt for good value, that caught our eye.
We believe there’s a play here for an industry that has been pounded and might be turning the corner. When an asset class or sector falls as far as the homebuilders did, it’s not uncommon for it to bounce back and recapture between 50 and 61.8 percent of its downward move. A 61.8% retracement off the lows would imply a gain of about 100% from today’s level, and that’s a lot of upside room left (assuming nothing more then simple mean reversion occurs). If you combine that with what looks like a major trend change, and then add the improvement in housing and industry fundamentals, we think the industry still looks attractive on a cyclical basis.
We first took a small position in homebuilders in our most aggressive models back in 2009, and then took another one last November. Those were trading positions, and we really hadn’t taken a position across the board until earlier this March. In the first quarter it was becoming apparent to us that a broad swath of the housing data was improving, and we were reading a number of analyst reports that were positive on the micro fundamentals for the industry. It was also significant that an improvement in the data was occurring at a time when there was still a lot of pessimism regarding the housing market, so we were hopeful that a lot of positive surprises could be generated if we were correct that both the macro and micro fundamentals were starting to work in favor of the industry.
Don’t get me wrong: Nobody here at Pinnacle thinks the housing market is going to go gangbusters from here. But markets move on the margin, and so the fact that it’s beginning to stabilize and pick up is a major change in the landscape for the U.S. economy and the industry.