Wow, what a tough week!

Posted by Eric LeRiche | June 25, 2010 .

Wall Street was looking for improving results from the housing market numbers on Tuesday and Wednesday, but instead all they got was two black eyes.

Double Ouch!

The existing homes sales report for May was released on Tuesday, and in a word, it was disappointing. May closed sales were unexpectedly down 2.2% from April (though still up 2.7% from May, 2009). And while inventory numbers fell 3.4%, we continue to have an 8.3 month supply, which is up from a year ago.

Some of that increased inventory was due to sellers trying to take advantage of the first time home buyer tax credit, by putting their homes on the market, and could decline in future months. Some of it may be due to increasing numbers of foreclosures, as banks try to resolve short sales and modifications more quickly.

Only 46% of the homes sold went to first time buyers, which was also less than expected. About 31% of all the sales were distress sales (foreclosures or short sales), which is similar to the numbers we have been seeing for quite awhile.

But overall, the number of sales was lower than expected, and most of the real estate related stocks sold off on the news.

The National Association of Realtors (NAR) retreated into their usual “CYA” mode, and blamed it on delays in processing mortgage applications, which hampered the closing of contracts prior to the end of the home buyer tax credit.

If that’s true, then the June numbers could get a boost from the eventual closings. But I will remain skeptical until we see the next reports.

From Bad to Worse

On Wednesday, the new home sales (contracts, not closings) came out, and the results were even worse. New home sales in May were down 32.7% from the previous month, and the annual sales pace total of 300,000 was far below the ridiculously overblown market expectations of 430,000.

The drop reversed two months of solid gains that were largely comprised of first time home buyers, who were trying to beat the April 30 contract deadline to receive the $8000 tax credit.

Following these reports, some economists are saying there’s at least a 20% chance of a double dip in housing prices. Before we share that conclusion, I think we have to remember that most people who wanted to buy a home this spring tried to go to contract before the April 30 deadline.

Therefore, it is not surprising to have a fall off in the number of new construction contracts. However, it is surprising to have a decline in the number of existing home closings.

So how do we profit from this mess?

This week I was asked to recommend a plan by which investors could profit from the housing numbers. Let me tell you, that’s not an easy task!

It would be a no brainer to suggest that you short the builder stocks, or the various real estate indexes. But these stocks have been beaten down so much in the last few years, the risk factor is beginning to outweigh the potential rewards for shorting that group.

And as I told you the other day, the real estate stocks have actually been one of the stronger sectors recently.

So you don’t want to be the last guy trying to squeeze into the pool when the water starts flowing the other way!

Watch out for that real estate “short squeeze”…

But one stock that I’m watching very carefully right now is PMI group, Inc. (NYSE: PMI), a holding company whose primary subsidy is the PMI Mortgage Insurance Company.

This is one of two listed companies (Radian, symbol: RDN, is the other) that insure conventional mortgages against loan default. Of these two companies, PMI has the superior relative strength, so let’s focus on that one.

In 2006, at the peak of the real estate market, PMI was a $50 stock. Today, following three years of real estate declines, and this week’s housing reports, it languishes around $3.35. As recently as April, when the market peaked, it was up near $7.

However, what intrigues me about PMI as a LONG TERM PLAY is that they have recently begun to insure homes in high risk states, such as California, Nevada, Arizona, and Florida. As I wrote in last week’s article, even the 5% down conventional loans with PMI are now back in fashion.

This means that going forward, with any kind of decent housing numbers, PMI should begin to insure more loans than they have in recent years, and that the PMI group is finally convinced that home values are NOT heading substantially lower.

Let me say that again. A company, whose financial future depends on home values securing a bottom, has decided to start insuring loans in the four riskiest states.

Can you see the light bulb going on over that paradoxical idea?

Wow, I have seen the light!

On the chart below, notice that with the bad housing numbers, PMI has now dipped slightly below support at the 200 day moving average around $3.50. It’s also fallen below the recent lows that have held support twice.

If PMI fails to hold at the 200 day M.A., the next long term support level is down around 3.00. So this is a crucial time for the stock.

So while I am recommending PMI as a long term play, I am NOT recommending that you buy it just yet. I believe that you will be able to buy it for a good deal lower than the current price within a short period of time.

We really need to see a solid improvement in the employment numbers, and in turn the future housing numbers, before PMI can be expected to reverse its downtrend and become a winner.

I would also like to see it hold its ground against the 200 day moving average.

One thing is for certain — with all of the weakness in the economy, the current mortgage interest rates are now absolutely fantastic. As I have stated repeatedly in recent weeks, investors seeking long term wealth will benefit enormously from buying inexpensive, distressed properties, with today’s cheap financing.

The confluence of already crushed prices, incredibly low interest rates, and an increasing population of renters (comprised of foreclosed home owners and those who cannot qualify for tougher loan standards) over the next 5-10 years, will produce a golden era for long term real estate investors, regardless of what prices do over the coming decade.

Look at these interest rates!

I know it’s hard for people to believe that, when all you hear is doom and gloom about housing prices. Sometimes when I hear bad news again and again, I find it challenging to keep the faith, myself.

But remember that investing in real estate and buying a primary residence are two entirely separate and distinct things.

In this market, I am much more confident about buying foreclosed investment property than about buying a primary residence – unless you also buy a foreclosure, and plan to occupy it for a very long time. And keep your eye on the performance of PMI stock, for what eventually could be a long ride back up the charts.

I will keep you posted and probably will recommend it as a long term pick soon

Cheers

Eric LeRiche

http://www.investorrules.com/VIPportfolio.html

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