Why PulteGroup, DR Horton and Lennar Are Good Buys Now

While the Case-Shiller 20-City Home Price Composite Index rose a healthy 5.1% year over year through August, meeting expectations, at the same time new home sales measured by the Commerce Department tumbled 11.5% from August to September. In other words, while housing prices are rising, actual home sales are falling. What are we to believe then? Is the housing market improving or not?

The answer is it is improving, and the mixed signals are due to a combination of varying degrees of time-lag and money supply fluctuations. From late June to late July this year, the M2 money supply measuring total cash, demand deposits, savings and short-term time deposits in the banking system was shrinking. Check Table 2, third column from the end, in the Federal Reserve Money Stock Measures report for that time period. This does not happen every year, but when it does it can cause economic contraction on a short-time lag. It is not surprising then that one month later, actual new home sales began to fall.

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Since relatively few sellers on the real estate market need to sell homes immediately, it takes longer for the home prices themselves to fall in response to monetary contraction. For that to happen, a much more protracted decline in money supply is needed, like the one we saw in 2008. Average M2 money supply declined all the way from mid-June to mid-October in 2008 by the same measures, four times the length of the contraction this year. While the housing market already was falling in 2008 for other reasons, the severe monetary decline that year accompanied the worst period of the housing free fall and assured that there would be no quick bounce back.

This year, the month-long contraction was only enough to put stocks in a mild panic that peaked in late August. Selling shares is much easier than selling houses, and it has more of an element of immediacy due to margin calls and emotional reflexes. That’s why a single month-long decline may be enough to disturb share prices, but not necessarily housing prices.

In any case, the M2 decline seems to have ended for now, and the dollar supply is climbing again. Stock indexes seem to have stabilized as well, and new home sales should rise in the coming months to reflect the monetary sea-change. That should give added support to the Case-Shiller index, and in turn give further fuel to home-building stocks.

Lennar and D.R. Horton look to be the more conservative buys. PulteGroup has been an underperformer this year and so looks to have a higher risk-reward ratio.

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