Why New Home Sales Doesn’t Tell The Story

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Just yesterday, I talked about New Home Sales and why it can push the economy in every which direction.  Now, we're going to see how traders react on headlines instead of hearing the whole story.

Wednesday's New Home Sales report revealed the following signs of immense strength in the housing sector:

1. Sales registered 1.047 million versus the expectation of 1.015 million -- a difference of 32,000, or 3.15%.
2. Sales were revised higher by 46,000 over the past three months.
3. Inventory levels dropped to 6.3 months worth of supply from 6.7 months worth of supply.

We know that the Fed expects the housing sector to slowdown, thereby creating a slowdown in the overall economy.  Traders know that, too.  So the stats above hit the wires Wednesday, traders began to plow into stocks, driving the Dow to an all-time high.  Bonds prices dropped, too, and mortgage rates leapt higher as a result.

I don't consider myself smarter than the traders, nor do I think I can out-smart the market, but I do have a pretty good recall and I remember reading an interesting story about 60 days ago from the Wall Street Journal.

Written by Ruth Simon and June Fletcher, the story headline read "Home Buyers Back Out Of Deals in Record Numbers" and the key quote was [emphasis added]:

"At a semiannual housing forecast conference last week in Washington, D.C., economists reported that contract-cancellation rates for big builders were running around 40% -- about twice as high as last year's levels."

Big builders sell new homes, so this quote tells us that 40% of new home sales are actually canceled before they are ever closed.  How strong do New Home Sales look now, I ask?  This little tidbit punches the data right between the eyes.

As interesting as the cancellations themselves are their major reasons.  As cited by the authors:

1. Buyers are angry when developers reduce price on similar properties
2. Buyers can't sell their old homes and invoke a contractual clause that let's them back out of the deal because of it

These are both issues that aren't likely to go away.  Developers will continue to "sweeten the pot" for new buyers in order to unload inventory, and sellers will continue to accept the contingency clause in purchase offers because buyer's have the psychological upper-hand nationwide right now.

In other words, it doesn't really matter if New Homes Sales are surging higher because it only measures contracts being written, not contracts being closed.

Let this be one more lesson to look deeper than the headlines for clues about the economy.

Source
Home Buyers Back Out Of Deals in Record Numbers
June Fletcher and Ruth Simon
The Wall Street Journal Online, November 6, 2006 http://www.realestatejournal.com/buysell/markettrends/20061106-fletcher.html?refresh=on