Contrarian Alert: Two Penny Stocks Tell a Hopeful Story About Housing

The Fed’s wish for a softening of inflation may be coming true as the jobs market seems to be cooling. The bullish side of the equation is that the Fed may be done raising rates. On the down side, more than a slight softening of the jobs market would entail rising risks of a recession.

Bond traders love it, and after some second thoughts about continuing the Santa rally, stocks seem to have gotten back into the year end spirit. Yet, as I describe below, a deep and very contrarian dive into the netherworld of penny stocks offers an interesting glimpse into a potentially positive future for one area of the housing market: the beleaguered existing home sector.

The Fed’s Ambivalence Is Worth Noting

I find it interesting that central banks are suddenly tiptoeing around the question of whether they will raise interest rates again. The markets are certainly betting that they won’t. And so far, the inflation data is encouraging. What’s of concern, however, is the increasingly rapid deterioration of the jobs market.

Certainly, we’ll know more when the official U.S. November payroll data is released on 12/8. But given the huge miss in job openings (JOLTS) numbers released on 12/5, and the fewer than expected private jobs report from ADP on 12/6, it looks as if the Fed’s wish for a softening in the labor market may be coming true. According to the JOLTS report there were 873,000 job openings in October, well below the 9.4 million estimate. ADP reported 103,000 new private sector jobs while the consensus was for 113,000.

Unfortunately, aside from the worse than expected JOLTS number, corporations are stepping up their layoffs. Recently, music streaming service, Spotify (NSDQ: SPOT) announced layoffs for 17% of its workforce while Wells Fargo (NYSE: WFC) announced that its costs for the current quarter will rise by $1 billion due to higher than expected costs of upcoming severance payments for future layoffs. Wells didn’t specify any numbers.

Meanwhile, recent purchasing manager data (ISM and PMI) painted a picture of falling input costs, slowing employment trends, and perhaps a slowing of the economy in 2024.

Bond Yields Break to New Lows

As I always say, purely from an investment standpoint, it’s not what the news says that matters, it’s how the market responds. Ahead of Friday’s employment data, the U.S. Ten Year Note yield (TNX), the benchmark for long term mortgages broke to a new low, and seems to be headed for a test of the all-important 4% area.

Should that happen, expect mortgage rates to fall to their lowest levels in months, with a test of the 7% level looming. Moreover, a precipitous fall in mortgage rates, will likely bring on a test of the 7% area. Should that psychologically important benchmark be broken, the housing market will likely deliver some fireworks.

The S&P Homebuilding Subindustry Index (SPHB) is at its highs for the year, so it will be interesting to see what happens here, as its action reflects investor expectations of the future for homebuilder stocks. And while the homebuilders have been at the top of the food chain for quite a while, as I describe below, there are some highly undervalued stocks in the existing home sector of the housing market.

Down the Penny Stocks Rabbit Hole

I’m not a big fan of penny stocks. I find them too risky to trade in my own account. And if I don’t trade something, I usually don’t recommend it. On the other hand, occasionally something flashes on my watchlist screen that grabs my attention. So down, the rabbit hole we go.

Recently, I noted that shares in cloud based real estate broker solutions Compass Inc. (NYSE: COMP) have been moving higher – up over 40% in the last few weeks. Sure, at just below $3 the stock is well off its IPO high of $22.78, achieved way back on its debut in March 2021.

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Since then, the best the company has been able to accomplish is to reduce its losses while delivering stable revenues, and improving hopeful metrics such as its recently reported improvements in EBITDA (earnings before interest, taxes, depreciation, and amortization). Another flicker of hope is that the company has been free cash flow positive for two straight quarters.

To be fair, the shares went public during one of the worst periods for existing home sales in history just as the Federal Reserve began its aggressive rate hike cycle. To put it bluntly, if there is no inventory of houses to sell, and mortgage rates are high then the odds of selling an existing home are low. And that’s what’s happened to Compass and other companies in the sector.

But here’s what makes this stock interesting. While it is clearly struggling, the company still has $220 million in cash on its books and it is not drawing from its line of credit. This is a sign of emerging discipline from the management team. And it could be what saves them from fading away.

The second penny stock to watch is Opendoor Technologies (NSDQ: OPEN). While Compass is in the brokerage business, Opendoor is in the business of buying houses, often in ill repair for bargain prices, sprucing them up and then flipping them. Suffice it to say that its business hasn’t fared much better than that of Compass, again due to the Fed’s squeezing of the housing market.

Part of it is self-inflicted as the company bought too many houses at high prices during the post pandemic blow-off in existing homes and then got stuck with them when the Fed began to raise rates. That said, however, there’s a big difference between Compass and Opendoor. The latter has $1.5 billion of cash on its balance sheet, which gives it much more room to maneuver in challenging markets.

Money Is Trickling In

The price charts for both stocks are certainly encouraging as they seem to be telling us the stocks have bottomed. In the case of COMP, the shares have held at $1.80 three times over the last twelve months. All the while the stock looks set to move above $2.60 and could well be headed for $3.

That’s the price point where things will get interesting as the 200-day moving average and a large cluster of Volume by Price (VBP bars) offer meaningful resistance. That’s the price area where investors who bought the stock in the summer of 2022, in hopes that the worst was over, are waiting to sell their shares, to just break even. If the stock can get above that price area, it could well move into the $4 and beyond price range.

On the other hand, OPEN is in a much stronger position having crossed above its 200-day moving average with little price resistance evident above. Note the small size of the VBP bars in comparison to COMP’s.

In addition, Accumulation/Distribution (ADI) has turned up as short sellers cover their positions while On Balance Volume (OBV) has been moving steadily higher as buyers have been moving in.

Why Bother with Penny Stocks?

You’re probably wondering why I’m even bothering with these stocks. Simply stated, they are canaries in the proverbial coal mine. In other words, if struggling companies such as Compass and Opendoor can find their way out of their current quagmires, then it may be a sign that the existing home market dynamics are improving.

Moreover, the positive money flows into these two stocks are a sign that investors are warming up to the idea that the Fed is done raising rates. For the housing market, it may also mean that the current tight supply scenario is about to change.

Bottom Line

The jobs market is cooling off. Bond yields are falling. These two events could be portents for a recession. Yet, investors are putting money to work in the bargain basement of the existing housing market.

So, what could go wrong?

If the November payrolls data surprises to the up side and if the upcoming inflation numbers (CPI and PPI) deliver negative surprises, bond yields will almost certainly rise and the potentially bullish scenario for the existing home market as well as homebuilding stocks could blow up in a hurry.

Still, from an investment standpoint, anyone with a few hundred dollars and some patience may find that, for once, making risky bets on penny stocks may actually pay off.

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