Housing Slowdown. After many years of gravity-defying performance, evidence is building that the UK housing market has finally started to slow –and potentially quite significantly. In particular, we note that the RICS survey has proved a good lead indicator of house prices; the latest survey suggests that: 1) house prices are now falling; 2) current sales volumes are already close to 10-year lows; 3) new buyer enquiries have only been lower ahead of the Iraq war; and 4) excluding London (which has just started to deteriorate itself) the picture looks even worse.
Warning signs from first-time buyers and buy-to-let investors. The marginal buyer of housing is traditionally the first-time buyer, however the first-time buyers’ share of loans has approximately halved over the last 10 years at the expense of buy-to-let investors. Both segments of the market now look at risk. Affordability for first-time buyers is at its lowest point since 3Q 1988 –house price inflation peaked in 4Q 1988. Buy-to-let activity is likely to slow due to weaker house prices and less favourable funding rates post the deterioration in credit markets. In addition, repossessions are rising, mortgage approvals (which tend to lead both house price inflation and retail sales growth) are slowing and mortgage interest rates are going up again.
Weaker house prices bad for consumer-facing sectors –but not banks. We have tracked the relative performance of sectors in five prior periods of house price dis-inflation/deflation over the last 20 years. Unsurprisingly, the worst performers tend to be consumer-facing sectors including House builders, Retailers, Media and Travel & Leisure. More surprisingly, a weak housing environment has not traditionally been bad for Banks –they have outperformed in three of our five periods and by an average of 13%. 
House builders profits only suffer if we see outright house price deflation. We have also analysed the impact of weaker house prices on sector EPS. Here we find that house builders’ profits only contract if house prices suffer outright declines (which we think is probable from here), whereas other consumer-facing sectors such as Retailers, Leisure, Food Producers and Media have seen negative earnings growth more often than not in previous periods of house price disinflation or deflation.
Sector preference –1) Banks; 2) Retailers; 3) House builders & Leisure. Although we question the validity of the underlying EPS forecasts we find the consensus 12m forward PE ratio for the consumer facing/rate sensitive sectors instructive in terms of our order of preference. Banks currently trade on a 12m forward PE of 9.1 –this is just 5% above its 12-year low and 27% below its 12-year average. Retailers trade on a 12m PE of 12.7 –this is 9% above its 12-year low and 17% below its 12-year average. House builders trade on a 12m PE of 8 –this is 70% above its 12-year low and 5% below its 12-year average. The Hotel & Leisure sector trades on a 12m PE of 15.3 –this is 83% above its 12-year low and just 3% below its 12-year average. 
Which stocks suffer from weak house prices? We have analysed the relative performance of consumer facing stocks across the five periods of house price disinflation/deflation that we identified. Stocks that underperformed in each of these periods include: BSkyB, McBride, Rank, Headlam Group and Laura Ashley. Stocks that underperformed the market in four of these five periods include: Trinity Mirror, Ladbrokes, GCap, Bellway, Johnston Press, Travis Perkins and ITV.