Weekly Overview: Housing & Mortgage

The Office of Federal Housing Enterprise Oversight (OFHEO) reported today that U.S. home prices grew at an annual rate of 3.5% in the 3rd quarter. Including the third quarter, home prices are up 7.7% in the past year, the slowest in three years. A year ago, prices were rising at 13.4%. In last 5 years, home prices have risen by a whopping 57%.

Also, according to an estimate released by the Commerce Department, sales of new homes fell 3.2% in October. New-home sales are now down 25.4% in the past year. Median sales prices were up 2% in the past 12 months to $248,500, reversing a trend toward falling prices year over year. In a separate report Wednesday, the Commerce Department said the U.S. economy grew at a 2.2% annual rate in the third quarter, an upward revision from the 1.6% initially reported.

The long-term mortgage rates fell for the fifth straight week. The rates are now lower than their year-ago levels. According to Freddie Mac's weekly survey, the 30-year fixed-rate mortgage averaged 6.14% in the week that ended today -- down from its 6.18% average last week. The rate was 6.26% one year back. The 15-year fixed rate averaged at 5.87% this week, again a slide from last week's 5.91%. At this time last year this rate was 5.81%.

Rate for 5-year Treasury-indexed hybrid adjustable-rate mortgages (ARM) averaged at 5.95% decreasing from last week's 5.99%. This rate averaged 5.76% a year ago. The 1-year Treasury-indexed ARMs have an average rate of 5.46%, down from last week's rate of 5.49%. At this time in 2005, the 1-year ARM averaged 5.16%.

Alternative Energy Investment

Unlike traditional energy companies which suffered a downturn in June but came up nicely thereafter, the alternative-energy shares could never get rid of that mid-year disillusionment of their investors.

For example, PowerShares WilderHill Clean Energy (PBW), an alternative-energy focused ETF (Exchange Traded Fund) is off by about 25% from their peak after a good run up there in the first half of 2006. Winslow Green Growth Fund (WGGFX) , a small-cap portfolio that has investments in clean-energy stocks, is also off by about 13% from its mid-year peak. A similarly focused midcap offering, New Alternatives Fund (NALFX) has, however, got back near its peak but another newer offering, Guinness Atkinson Alternative Energy Fund (GAAEX) is off by about 21% from its mid-year peaks.

The main difficulty in playing in this field comes from a limited understanding of the valuation of such stocks and their future. Everyone understands that Ethanol or solar energy would assume a great role in future but nobody is sure enough to tell when exactly these could play a significant role in the world dominated by conventional energy sources like oil and gas. For example, riding the hype generated by rising crude oil prices in mid-May, Pacific Ethanol Inc. (PEIX) , which claims Bill Gates as major investor, reached a 52-week high of $44.50, but was exchanging hands at $17.75 at closing bell today.

But many proponents of alternative power maintain that the good time for such stocks would arrive sooner than what the disillusioned investors predict. Their faith hinges on several broad factors: the ever-increasing thirst for energy from developed countries as well as China and India which are industrializing themselves at a rapid pace; the finite nature of fossil fuels; global warming, and the uncertain geopolitics of oil. In such a world, they say, it pays -- both economically and politically -- to find other power sources. And so, if you can put your trust on alternative energy and have time and patience on your side, it's probably right time to enter this sector.

Conforming Loan Limit

Currently, for most of the country, the maximum limit for mortgage loan is $417,000. This limit is typically increased each year by the level of home-price inflation. The conforming loan maximum is the largest loan that can be purchased by mortgage giants Fannie Mae or Freddie Mac. Loans larger than the maximum, known as jumbo loans, typically carry higher interest rates.

According to a statement released by the Office of Federal Housing Enterprise Oversight (OFHEO), the maximum conforming loan limit for U.S. mortgages will be frozen at current levels for a year, and then adjusted for 2008, if home prices show a decline from October 2005 to October 2006. Such a decline in price appears likely this year as the September number showed a 3.1% decrease.

The October price data will be published Nov. 28. If prices rise year-over-year, then the maximum loan limit for 2007 would be raised as usual. Any mortgages previously purchased or guaranteed under a higher limit should not be affected by any reduction of the limit. But households and lenders who are making decisions today may get affected by the limit put in effect next January.

XHB, ITB, PKB -- Homebuilders' ETF

As we cautioned our readers again and again (see past posting), the housing slump indeed turned out to be more pronounced than those in the "soft landing" camp had expected. A government report late last week showed housing starts plunged 14.6% in October to the lowest level in more than six years. Building permits fell 6.3%, the largest percentage decline in seven years. Home builders have seen orders plunge and many buyers are canceling contracts. Cancellations are being driven by fears of price declines and because buyers are experiencing difficulty selling their own homes.

Within a few months, the sector would start looking attractive for investment. We believe it would still be a risky affair to put money in any individual stock in this sector. It's a good idea to keep a watch on the following exchange traded funds (ETF) which provide good diversification.

SPDR Homebuilders (XHB)
iShares Dow Jones U.S. Home Construction (ITB)
PowerShares Dynamic Building & Construction Portfolio (PKB)

The expense ratio of XHB is the lowest 0.35%, whereas that for ITB is 0.48% and for PKB the ratio is 0.60%. XHB is also an equally-weighted fund holding almost equal stake of 5% for each of 20 stocks in its portfolio (for more on equally-weighted fund, read our past posting). All these ETFs are down by 30-40% from their 52 week high after the free-fall the whole sector experienced during April-August.

Mortgage Rate Down

As the threat of inflation seems to be receding away, the mortgage rate takes a dip in this week. Both the Producer Price Index (PPI) and Consumer Price Index (CPI) for October came in lower than expected and bond yields dropped, pulling mortgage rates lower.

Also, according to an estimate released by the Commerce Department, starts of new homes plunged 14.6% last month to a seasonally adjusted annual rate of 1.486 million, the lowest level since July 2000. Building permits fell as well, down 6.3% to a seasonally adjusted annual rate of 1.535 million, the lowest in 9 years. It was the largest percentage decline in permits in 7 years.

After increases in two of the last three weeks, mortgage rates reversed the trend and went down this week on lower than expected figures for the 3rd quarter gross domestic product. Lower rates may generate a spurt of refinancing by those who want to get out of ARMs that are scheduled to reset in the next year.

According to Freddie Mac's weekly survey, the 30-year fixed-rate mortgage averaged 6.24% in the week that ended today -- down from its 6.33% average last week. The rate was 6.37% one year back. The 15-year fixed rate averaged at 5.94% this week, again a slide from last week's 6.04%. At this time last year this rate was 5.90%.

Rate for 5-year Treasury-indexed hybrid adjustable-rate mortgages (ARM) averaged at 6.04% decreasing from last week's 6.08%. This rate averaged 5.86% a year ago. The 1-year Treasury-indexed ARMs have an average rate of 5.53%, down from last week's rate of 5.55%. At this time in 2005, the 1-year ARM averaged 5.20%.

8 Dividend-seeking ETFs

Today we present a list of eight Exchange Traded Funds (ETFs) which invest in good companies that consistently pay out dividend:

In November 2003 Barclays Global Investors introduced the first dividend ETF, iShares Dow Jones Select Dividend (DVY). That fund carries an expense ratio of 0.4%. The timing of its introduction was perfect and it gained a lot taking advantage of the 2003 federal legislation that slashed the income tax rate to 15% on dividends paid out by corporations. The fund's tracking index targets the top 100 domestic stocks by dividend yield, screened by dividend-growth rates, payout ratio and trading volume.

PowerShares Capital Management offers as many as 4 ETFs that invest in income-producing stocks: PowerShares High Yield Equity Dividend Achievers (PEY) , PowerShares Dividend Achievers (PFM) and PowerShares High Growth Rate Dividend Achievers (PHJ) hold U.S. companies, while PowerShares International Dividend Achievers Portfolio (PID) tracks foreign stocks.

State Street Global Advisors manages the SPDR Dividend ETF (SDY), which follows a Standard & Poor's index measuring the performance of the 50 highest-yielding domestic stocks that have consistently raised dividends for at least 25 years.

First Trust Morningstar Dividend Leaders (FDL) is based on a benchmark of about 100 high-yielding companies with a history of consistent payouts.

Vanguard Dividend Appreciation Index Vipers (VIG) is the first dividend-seeking ETF from Vanguard Group and tracks the Mergent Dividend Achievers Select Index. It began trading on the American Stock Exchange in late April and carries a low expense ratio of 0.28%. "Vipers" (short for Vanguard Index Participation Equity Receipts) are ETFs designed as separate share classes of regular Vanguard index funds - in this case the Vanguard Dividend Appreciation Index Fund (VDAIX).

In one of our past postings we discussed relative merits and demerits of iShare's DVY and Powershare's PEY.

Rydex Equal Weight ETFs

In 2003, the Rockville, Md.-based Rydex investments launched Rydex S&P Equal Weight (RSP), an exchange traded fund (ETF). The fund aims to invest 0.2% in each of the 500 stocks in the S&P index. The equal weighting isn't exact because stock prices are constantly shifting, but Rydex rebalances the ETF on a quarterly basis to get back to the target. The fund has amassed a respectable $1.8 billion of assets since its 2003 launch.

Most of the indexes to which ETFs are benchmarked rank individual companies according to market capitalization, thus sometimes putting too much focus to larger companies. The Energy Select Sector SDPR (XLE), for instance, has more than 36% concentrated in just two stocks: Exxon Mobil (XOM) and Chevron Corp (CVX).

Rydex is now looking to build on the success of RSP with sector-based funds with a similar strategy. Last week they introduced a few such ETFs. For example, Rydex S&P Equal Weight Energy ETF (RYE) attempts to equal-weight its 29 holdings with each stock at roughly 3.4%. Others are: Rydex S&P Equal Weight Utilities (RYU), Rydex S&P Equal Weight Consumer Discretionary (RCD), Rydex S&P Equal Weight Consumer Staples (RHS), Rydex S&P Equal Weight Financials (RYF), Rydex S&P Equal Weight Health Care (RYH), Rydex S&P Equal Weight Industrials (RGI), Rydex S&P Equal Weight Materials (RTM), Rydex S&P Equal Weight Technology (RYT), Rydex S&P Equal Weight Utilities (RYU). The new equal-weighted sector ETFs from Rydex have annual fees of 0.5% of assets.

Slump in Housing Market Continues

In our posting dated Sept 26 we said we failed to understand who were still buying stocks of the nation's largest home builders like KB Home (KBH), Lennar (LEN), Pulte Homes (PHM), Toll Brothers (TOL), Beazer Homes (BZH) and Hovnanian (HOV) because an ugly sky was looming large over the housing market.

All those companies have been lowering guidance on home sales in recent weeks, reporting lower prices and excess supply of homes on the markets. Today morning luxury home builder Toll Brothers Inc. said home-building revenue fell by 10% and signed contracts were down by 55% compared with a year ago. The company, which released its quarterly outlook ahead of earnings, also said it will incur a hefty charge against profits as it pares down the number of lots it controls.
Also, Beazer Homes USA Inc. reported a 44% decline in profit as higher revenue was offset by squeezed margins. The company said there was "significant" discounting in most markets. New orders for Beazer fell by 58% to 2,064 homes from 4,937 last year, as the housing market continued to slow. It has cut 1,000 jobs, or 25% of its workforce.

Back in September we were surprised because at that time these stocks had managed to register some small but positive gain. Surely some people out there were getting greedy and expecting these stocks to have a similar run they enjoyed over the last few years. Some part of the media was propagating a dream that the housing sector would come back faster and quicker than expected.

We told you to just remember faces and names of those analysts and after one year find them out and grill them again with your questions. They would surely have lot of intelligently manipulated reasons why the dream propagated by them were not seen anywhere. But by that time you would loose money in these stocks and those analysts will not be responsible for that.

We repeat ... Make no bone about it -- the housing sector is in real trouble. Over the last few years people bought more than what they could afford by accepting (without thinking) those terms and conditions of interest-only loans or ARMs and now they are getting squeezed by increased interest rate. The single-digit PE ratios of those home-building companies look cheap but uncertainties in months ahead are clouding over them and it's better to avoid them until they sink further and find some other lower ground. True to our prediction, that process has started already.

Mortgage Rate Down

After increases in two of the last three weeks, mortgage rates reversed the trend and went down this week on lower than expected figures for the 3rd quarter gross domestic product. Lower rates may generate a spurt of refinancing by those who want to get out of ARMs that are scheduled to reset in the next year.

According to Freddie Mac's weekly survey, the 30-year fixed-rate mortgage averaged 6.31% in the week that ended today -- down from its 6.40% average last week. The rate was exactly same one year back. The 15-year fixed rate averaged at 6.02% this week, again a slide from last week's 6.10%. At this time last year this rate was 5.85%.

Rate for 5-year Treasury-indexed hybrid adjustable-rate mortgages (ARM) averaged at 6.05% decreasing from last week's 6.14%. This rate averaged 5.76% a year ago. The 1-year Treasury-indexed ARMs have an average rate of 5.53%, down from last week's rate of 5.60%. At this time in 2005, the 1-year ARM averaged 5.09%.

New ETFs: Waste & Steel

Last May exchange-traded fund (ETF) newcomer Van Eck Global listed its first ETF, the Market Vectors - Gold Miners ETF (GDX) . Since its launch the fund has gathered in about $260 million in assets. On Monday this New York investment adviser company listed a pair of new offerings on the American Stock Exchange.

The first one, Environmental Services ETF (EVX) is already being dubbed as the "trash" ETF. It tracks an Amex index of 24 companies involved in waste management, recycling and environmental management or consulting. Top holdings include Republic Services Inc. (RSG)
and Waste Management Inc. (WMI).

The other new ETF, Market Vectors - Steel ETF (SLX) tracks another Amex benchmark targeting 39 companies involved in steel production and fabrication as well as the extraction and reduction of iron ore. Index constituents include Arcelor Mittal Steel Co. (MT), United States Steel Corp. (X) and South Korea's Posco (PKX).