Over the last few weeks, I’ve turned more constructive on the homebuilder sector as even though mortgage rates have climbed and sales have slowed, the elephant in the room – tight housing supply in the face of high demand favors homebuilders. Yet, the key to when we see the next full frenzy in homebuying develop depends almost fully on interest rates.
The Lay of the Land
How strong are the homebuilder stocks? As I recently wrote, the sector is suddenly outperforming expectations. Certainly, price charts don’t lie, as I will discuss below. Yet, perhaps the most interesting aspect of the resurgence in many of these stocks and current recovery is the underlying status of the housing market.
Here is a summary of recent data:
· Existing home sales rose 3% in January because of lower mortgage rates late in 2023 – this is a plus-minus factor for homebuilders. On the one hand, a low supply of existing homes drives business toward the homebuilders. On the other, it’s a sign that the overall housing market remains highly interest rate dependent and may not fully thrive until mortgage rates drop for an extended period;
· Pending home sales collapsed in January– the most recent pending home sales numbers put a damper on the encouraging existing home sales for January as the lower mortgage rates from late 2023 evaporated;
· New Home Sales remain steady – January new home sales grew by 1.8% year over year and 1.5% month over month.
· Housing starts are lower – this should keep supplies in favor of builders;
· Mortgage Rates – with the average 30 year rate hovering near 7%, many potential buyers are holding back. Any dip in rates is almost certain to bring out buyers from the sidelines.
Bond Yields and Mortgage Rates
The release of the Fed’s most watched inflation gauge, the Personal Consumption Expenditures Price Index (PCE) on 2/29/2024 met expectations when it delivered a 2.4% increase in inflation year over year. It’s projected to grow at a 2.8% rate for 2024, still above the Fed’s 2.0% inflation target.
You’d expect the bond market to sell off and yields to rise on this number. In fact, the opposite happened. The U.S. Ten Year Note yield (TNX), the benchmark for mortgage rates fell as low as 4.22% intraday before reversing, while still hovering about the 4.25% yield area.
A move below 4.17% on TNX would likely be very bullish for mortgage rates and the homebuilders.
Meanwhile, the headlines blared that mortgage rates (MORTGAGE) rose above 7%. Yet, the likelihood that they will be lower next week, given the fall in TNX is better than 50-50 barring a nasty turnaround in the bond market.
Not all Homebuilders are Equal
The turnaround in the homebuilder stocks is clearly underway. But there’s a subtle change. While in the past rally, most of the stocks in the sector rose in tandem, in this rally, it’s more of a company specific rally.
Certainly, it’s enough to give the entire sector a lift, as you can see in the shares of the SPDR S&P Homebuilders ETF (XHB), which as I suggested here last week, had an upward bias.
XHB has crossed the century mark and is showing signs of moving steadily higher, as long term Joe Duarte in the Money Options.com holding Lennar (LEN) is holding up quite nicely. Note the bullish double rise in Accumulation/Distribution (ADI) and On Balance Volume (OBV) in LEN. Combined these two indicators add up to one thing – money is moving in. I own shares in LEN.
In contrast, fellow homebuilder Meritage (MTH) continues to lag. It will be interesting to see what happens to MTH if interest rates turn lower. Compare the ADI and OBV lines between LEN and MTH and you can see investors are indecisive as to how to proceed with MTH.
Bottom Line
Homebuilder stocks are in the early stages of what could be a significant move higher fueled by the combined influences of tight housing supplies and the potential for lower interest rates if inflation data is seen as favorable by the markets. Certainly, this is a tentative uptrend which is not likely to last if interest rates reverse their recent consolidation and begin another move higher. Not all homebuilders are acting as strongly as others so being selective is the key to success.
Thanks to everyone for their ongoing support. I really appreciate it.
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