How the Fed whacked my stock – and the market overreacted

Since Ben Bernanke indicated that the Fed will begin tapering its purchases of bonds later this year, home builders and construction material stocks have been slammed. Building products giant USG Corp., which was in decline even before these announcements, has been hit especially hard.

As of June 30th, USG is down over 20% YTD, while the market has been up substantially over the same period. Over half of my portfolio is tied up in USG stock, and this decline has had a negative impact on the portfolio’s results.

USG Chart

USG data by YCharts

I feel much of this decline can be attributed to the fact that investors have lost patience with the lack of profits from USG, which earned only $0.02 per share in the first quarter of this year despite an improving economy.

The markets have interpreted the latest news of the Fed potentially reducing bond purchases as a signal that mortgage interest rates are set to rise.

Homebuyers taking out a mortgage can only afford to pay so much each month, and rising rates will make homes less affordable, potentially hurting the housing market. For a company heavily leveraged to the housing market, like USG, this would be very bad news.

I believe that all the evidence points to an overreaction by the markets to a potential decline in the housing market. Let’s take a look at some recent housing related news.

Existing home sales in May rose with strong price increases. Total existing home sales rose 4.2 percent to a seasonally adjusted annual rate of 5.18 million in May which is 12.9 percent above the 4.59 million-unit pace in May 2012.

Existing-home sales are at the highest level since November 2009 when the market jumped to 5.44 million as buyers took advantage of the pending expiration of a home-buying tax credit.

New home construction has also been improving. New home sales rose 2.1 percent in May compared with April to a seasonally adjusted annual rate of 476,000, the highest level since July 2008.

The median price of a new home sold in May was $263,900, up 3.3 percent from a year ago.  Home Builders sentiment, which is a leading indicator, has also recently turned bullish, with a reading of 52.

Readings above 50 mean more builders see market conditions as favorable rather than poor. It was the first time the index has climbed above that dividing line since April 2006.

The recent housing data has reinforced my belief in a market overreaction in USG stock and for now I will be keeping my portfolio highly concentrated in USG.  However, as mortgage rates rise, I will be keeping a close eye on the data points to see the effect it is having on the housing market and make adjustments to my portfolio as necessary.

The investments discussed are held in client accounts as of June 30, 2013. These investments may or may not be currently held in client accounts. Certain information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The manager believes that such statements, information and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.

  • bosco

    With due respect, Felix, there are really two reasons you were stating here. Mortgage rate and USG’s own performance. Blaming the good chairman is probably a good title but doesn’t make sense

    Ultimately, USG and OC etc should perform between the housing and home improvement. So, maybe homebuilders like TOL and mREIT like AGNC on one end and home improvement shops like HD and LOW on the other

    Granted that USG has some legacy issues (asbestos) it should really perform better without any excuses

    disclosure: I do have USG in my holdings

  • James

    Felix, how does allocating 66% of your portfolio to one stock adhere to your philosophy “My primary goal is preservation of capital with significant appreciation.” especially this one – I mean this could go to $5 quickly…Please explain.

    • Felix Tong

      James,

      Great question. As the model’s description continues, it describes that purchases are made with a significant perceived discount to intrinsic value, and the goal of the portfolio is to outperform over a complete business cycle. My philosophy is that if a stock is purchased at a significant discount from intrinsic value, over the long term the portfolio with avoid permanent loss of capital by providing a margin of safety in the purchase price. The position in USG was taken at much lower prices than USG trades at today and eventually grew into the overweight position it is now. I am more of a buy and hold investor I am reluctant to trade in and out of stocks unless the stock is significantly overvalued. Stocks are volatile over the short term and USG especially so, but stocks generally trend toward their underlying fundamentals over the long term, and I believe the long term outlook for USG remains positive.

      Felix