US Housing Market: Big Short 2.0?

House prices in the US have taken a dramatic turn to the downside in the middle of the summer when prices normally rise. Is it a warning sign of worse things to come?
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The potential movers

Next week, the US reports the latest series of data on house construction, which might not get as much attention as it deserves with the Fed meeting around the same time. The focus on the fight against inflation has left some of the collateral damage ignored: the US existing home sales have been . Not only have home sales dropped to the lowest level since the pandemic, but they are well below pre-pandemic levels, and there haven't been this few house sales since 2015.

Median , which might be some relief for major home builders facing higher prices for building materials.

DR Horton and Lennar (which reports next week) have seen slowing demand, and have cut their outlook for the rest of the year. A good deal of this can be attributed to affordability: the benchmark 30-year mortgage rate popped above 6.0% this week, the highest it has been since the subprime crisis. With the Fed expected to raise rates at least 75bps next week, mortgage rates are expected to continue to rise.

What's coming up

A deeper dive into DR Horton's results shows an interesting pattern. Profit margins rose substantially by 540bps last quarter, aided by increasing average sales prices. However, the cancellation rate also jumped to 24%, the highest since the subprime crisis.

What that implies is that "average" prices are being skewed higher because the bottom end of the market is disappearing. People with the money to buy more expensive homes keep doing so; people who were facing tighter financial conditions have stepped away from the market.

US housing starts are expected to fall again to 1.43M in August, compared to 1.45M in July. Homebuilders have been looking to wind down the inventory of open homes, and sell further along the construction process to ensure sales and lower the cancellation rate. However, construction firms at the higher end of the price spectrum, such as Toll Brothers and Taylor Morrison seem to have more resilient customer bases, for now.

DRH Head & Shoulders?

DR Horton's share price has recently retested the 50-day average at $75 and fell to the 50% Fibonacci retracement of the $25-$110 leg near $68. It has been rangebound, with a similar pattern forming around the same time in 2020.

Combined with the top, long-term price action hint at the right shoulder of an H&S formation. Often a H&S will complete by the golden ratio, which is near $58. But sliding down to $50 would be possible as both shoulders are quite shallow unless the weak attempt at the golden ratio
completed the pattern.

Upward resistance above the SMA lies at the 38.2% Fibonacci near $78.00, and above there at the 200-day SMA observed at $80.

Key takeaways

US home sales are well below pre-pandemic levels due to increased cancelation rates from rising mortgage rates, but with the focus on fighting inflation, this has been left largely ignored. It is the bottom end of the market that is disappearing, skewing average prices higher, whereas people with money continue to buy. As US housing starts are expected to fall again, homebuilders will look into winding down the inventory of open homes, and selling further along the construction process.