Hedge Against Falling Real Estate (SRS)

By Mark Whistler | May 23, 2007 AAA

The current real estate environment is like a concrete mansion built on ten stories of wooden planks. And right now, the timber is starting to bow... If it comes down, it's not going to be pretty.

On May 15, the NAHB Housing Market Index showed a three-point decline in homebuilder optimism to 30, the lowest level since 1990. What's more, optimism for expected sales over the next six months is at the lowest level in over 20 years.

At the heart of the problem, national foreclosure statistics are at an all-time high, and the subprime market is still a ticking time bomb. Though foreclosure rates improved slightly in April, March was one of the worst months on record, with a 47% year-over-year increase in repossessions. On a quarterly basis, foreclosures were up 27% in the first period of 2007, over 2006.

But, check this out: in 2006 foreclosures were up 42% over 2005, with 1.2 million houses going back to the bank. This means that one in 92 households lost their home over the year. And the number of foreclosures is expected to double in 2006.

What We Have Here is a Failure to Communicate
Let's face it, no matter how rosy a picture most realtors paint, real estate markets across the nation are a mess. And, the FOMC is certainly not doing anything to help. It can't. With gasoline prices over $3 a gallon, if the Fed lowers the over night rate, inflation will shoot through the roof. The Fed heads have their hands tied, and there's not much they can do to help right now.

So, this leaves us at the point where we must ask... what now? Is the bottom here yet, and if not, where's the bottom.

Limbo! How Low Can You Go?
There's a type of chart used by some analysts called "bullish percent charts", which measure market or sector sentiment by dividing the number of stocks in a certain sector (or index) trading with Point and Figure buy signals, by the total number of stocks in the respective index or sector.

Don't worry. I'm not getting into technical analysis here. The reason I'm referencing bullish percent charts, is because, really, when an entire sector is going gangbusters, or falling through the floor, a potential reversal could be looming. However, you're going to hate me when I tell you that there's no such bullish percent chart for real estate. However, I would like to point to the already mentioned NAHB, which is nearing all-time lows. Basically, what I'm saying, is that because foreclosures and sales are going to get worst throughout the year potentially, most investors are throwing in the towel... Which could mean we are near a bottom - food for thought.

Never Try To Catch a Falling Knife
At present, most homebuilder stocks have been smacked down to levels not seen since 2004. Take KB Homes (NYSE: KBH), or Lennar (NYSE: LEN) for example. It's clear, these stocks have been beat up since their climax in 2005. And it's tempting to take positions, I know. The problem is there could still be some downside left within the sector, especially if foreclosures continue throughout the year.

Personally, I have to say many of these stocks are very enticing, as many are trading with such ridiculously low price to sales ratios; it's hard not to think about buying the whole sector. However, if we did that, we would be trying to catch a falling knife. Before actually taking positions in homebuilders, it may be a good idea to at least wait until the stocks stabilize above their 50 and 200 day moving averages, something that will indicate sentiment returning.

In the mean time, investors looking for a way to hedge national real-estate woes, can consider UltraShort Real Estate ProShares (AMEX: SRS) exchange-traded fund. UltraShort Real Estate ProShares is a "double inverse ETF". What this means is that for every 1% the Dow Jones U.S REIT Index falls, this fund increases 2%. However, beware that if the DJUSRI climbs 1%, SRS will decline 2%. (To learn more about ETFs, see Introduction To Exchange-Traded Funds and How To Use ETFs In Your Portfolio.)

There is risk. However, should U.S. real-estate markets (and REITs) see further downside, the UltraShort Real Estate ProShares are a great way to hedge.

Exit is Everything.

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