Investment Contrarians

Is a Bubble Developing in Housing?

By for Investment Contrarians |

Bubble Developing in HousingRecently in these pages, I talked about how the government, the Treasury, and the Federal Reserve were creating an artificial economy that was supported by cheap money and low interest rates.

One of the major benefactors of this cheap money was the housing sector, which is now sizzling hot. The median price of an existing home in the U.S. was $173,600 in January, up 12.3% from an average of $154,600 a year earlier. (Source: United States Census Bureau web site, last accessed February 27, 2013.)

Driving the renewed buying in the housing sector has been the environment of near-zero interest rates. The Federal Reserve has been injecting additional liquidity into the economy and mortgage market via its $85.0 billion in monthly bond purchases. The problem is that the low interest rates and easy money have driven the excess buying of homes and investment properties, as speculators jump into the housing sector, looking for deals and driving up home prices.

My concern is that the buying may be creating another potential bubble in the housing sector. You may not believe it, but I view this as a possibility. Housing starts in January showed some stalling. And now, with the sequestration budgetary cut set to take effect tomorrow, the automatic $85.0 billion in annual budget cuts (the planned sequester will total $1.2 trillion over the next decade) could have a widespread impact on the country and the economy, including program cuts, job losses, and economic chaos. The Congressional Budget Office (CBO) has warned that the U.S. economy could contract by 1.3% in the first half of this year if the sequester is allowed to take hold.

So let’s assume the sequestration does occur. With the associated likelihood of slowing in the economy, the Fed may have little choice but to maintain its low interest rate policy. The aftermath could be more buying in the housing market, but given the expected impact on jobs and the economy, we could be set for softness in the housing sector.

Home prices, representing another key piece of the housing sector, are edging higher; the S&P/Case–Shiller U.S. National Home Price Index, comprising the 20 largest U.S. metropolitan cites, increased a better-than-expected 6.8% in December, representing the eleventh straight up month.

While the higher prices suggest a healthier housing sector, I’m concerned with the fact that the rebound has largely been driven by low interest rates. What will happen to homeowners and speculators when interest rates begin to ratchet higher?

Here, you will have homeowners and investors, faced with higher payments, who may be forced to liquidate. The problem is that if many do this, it would create a bubble in the housing sector.

The chart of the SPDR S&P Homebuilders (NYSEArca/XHB) index below shows the upward trend in the housing market from the October 2011 bottom to its high just prior to the relapse. Technical indicators in the chart point to more potential downward moves to come.

SPDR S&P Homebuilders Chart

Chart courtesy of www.StockCharts.com

While I’m not saying a housing sector bubble is inevitable, I am saying that there is a chance it could happen. As such, you want to be prepared for this possibility.

An investment strategy is to buy exchange-traded funds (ETFs) in housing that make money when the sector weakens. A couple of examples of ETFs you might consider are ProShares Short Real Estate (NYSEArca/REK) and Direxion Daily Real Estate Bear 3X Shrs (NYSEArca/DRV).

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