Homebuilders to Rally as Bet on Taper Premature: EcoPulse
Shares of U.S. homebuilding companies have fallen more than 20 percent since May, even as home-improvement retailers rose to a record high, a sign some investors are too pessimistic that higher mortgage rates could derail new construction.
The Standard & Poor’s Supercomposite Homebuilding Index -- which includes PulteGroup Inc., Lennar Corp. and nine other companies -- has declined 21 percent since reaching the highest level in almost six years on May 14. Meanwhile, the S&P 500 Home Improvement Retail Index -- comprising Home Depot Inc. and Lowe’s Cos. -- has risen 5.2 percent.
These two groups had been trading largely in sync since August 2011, which makes sense because they’re “from a common tree, but different branches,” said John Manley, chief equity strategist at Wells Fargo Funds Management in New York, which advises on $233.6 billion in assets.
Their performance began to diverge after May 1, when Federal Reserve Chairman Ben S. Bernanke said the central bank would continue buying $85 billion of bonds a month and the policy-making Federal Open Market Committee was prepared to accelerate or slow its stimulus program in response to changes in inflation and the labor market.
On May 22, Bernanke told the Joint Economic Committee of Congress the economy still was restrained by high unemployment and government spending cuts, and raising interest rates or reducing the asset purchases too soon would endanger the economic recovery.
Stocks erased an early rally and the yield on 10-year U.S. Treasuries rose above 2 percent that day for the first time since March after Bernanke said the Fed could “take a step down in our pace of purchases” in the “next few meetings” of the FOMC if there were “real and sustainable progress in the labor-market outlook.”
Amid speculation the Fed would begin tapering, the average fixed rate on a 30-year mortgage rose to a two-year peak of 4.67 percent on Sept. 5 from 3.4 percent on May 1, according to Bankrate.com data. It has since moderated to 4.13 percent as of Oct. 30.
All this provided “fewer and fewer” positive drivers for the homebuilding index to continue to rally, particularly after it had climbed almost 230 percent in less than two years, Manley said. It and the home-improvement retail index reached the widest differential in more than two years in August.
At the Sept. 17-18 FOMC meeting, the central bank unexpectedly refrained from reducing the pace of its purchases, saying it needed more evidence of lasting improvement in the economy and warning again that an increase in interest rates threatened to curb the expansion. Homebuilding stocks jumped 6 percent on Sept, 18, the biggest gain in two months.
With quantitative easing extended and Janet Yellen, perceived to be accommodative on monetary policy, nominated as the next Fed chairman, the homebuilding index has regained some of its losses and could “catch back up” with its home-improvement counterpart, said Michael Shaoul, chairman and chief executive officer of Marketfield Asset Management LLC in New York, which has about $17 billion in assets. It has recovered 11 percent since Sept. 5, after falling 29 percent in the preceding four months.
Shaoul said some investors still may be concerned about sluggishness in new construction, which hasn’t experienced as strong a rebound as sales of existing homes.
Previously owned single-family houses sold at a 4.7 million annual pace in September, 21 percent above the seasonally adjusted average of almost 3.9 million units since 1980, according to data from the National Association of Realtors. The annual rate for new one-family home sales in August was 421,000, about 39 percent below the 694,740 annual average since 1980, based on figures from the Commerce Department.
Shaoul said he doesn’t share the investors’ concerns because construction is starting to improve after “consumers stepped out of this part of the market” during the 18-month recession that ended in June 2009.
“I don’t believe it’s possible to have a healthy existing-home market and new one that’s near depression levels for several years,” he said.
Recent earnings from homebuilders also are encouraging. Nine companies in the index reported quarterly results in September and October and all beat analysts’ estimates.
The homebuilding index rose about 3.3 percent on Oct. 24, the same day Bloomfield Hills, Michigan-based PulteGroup -- the second-largest builder by market value -- released third-quarter earnings of 45 cents a share, topping the 36-cent average estimate. D.R. Horton Inc., the largest U.S. homebuilder, is scheduled to report fiscal fourth-quarter results Nov. 12.
The rise in the index is a bullish indicator for these stocks, according to Jim Stellakis, founder and director of research at Greenwich, Connecticut-based research company Technical Alpha Inc. Recent gains show investor worries are dissipating after some already made “easy money” underweighting this group, he said.
Even so, growth in new orders has been sluggish relative to investor expectations since May, said Kenneth Zener, an analyst in San Francisco at Keybanc Capital Markets Inc. “Homebuilders are experiencing seasonal rather than cyclical trends this year.”
Amid a backdrop of higher mortgage rates, “some consumers chose to step back from the market” and are taking longer to make purchasing decisions, Richard Dugas, chairman of PulteGroup said on an Oct. 24 conference call. Still, “the recent slowdown in demand will prove to be a modest pullback in an ongoing multi-year recovery in housing.”
Similarly, traffic is “very good” for M/I Homes Inc. at its models and online, even as sales have slowed, Chairman Robert Schottenstein said on a conference call the same day. “We continue to believe that overall demand and the fundamentals for improving housing conditions remain in place.”
Companies that acquired land at a lower cost -- such as Toll Brothers Inc. and Miami-based Lennar -- are poised to do better than their peers in this economic cycle, Zener said, adding this is one reason he maintains buy recommendations on these two builders, along with D.R. Horton.
Meanwhile, the home-improvement retail index has been mostly impervious to speculation about rising interest rates, as this group traded at a record high on Oct. 30, Stellakis said. Shares of Lowe’s have led this index higher, rising 16 percent since May 14, while Home Depot is up less than 1 percent.
Shaoul’s confidence in the industry’s continued recovery is underscored by recent reports from companies that supply products to home-improvement retailers, he said. There’s “no sign” the housing market is falling apart, which is one reason his fund is invested in stocks in both groups, he said. “When we play a cycle, we like to play the entire food chain.”
Whirlpool Corp. sees “positive trends” in both new construction and existing-home sales, Marc Bitzer, president of the company’s North America unit, said on an Oct. 22 conference call. Fortune Brands Home & Security Inc. sees the new-construction market “still on track to grow at 20 percent this year” and gains probably will continue into 2014, as demand outstrips supply in many U.S. markets, Chief Executive Officer Christopher Klein said on an Oct. 23 conference call.
These companies, which manufacture appliances and fixtures sold at retailers such as Home Depot and Lowe’s, also are buoyed by repair and remodeling activity, Zener said. Whirlpool, based in Benton Harbor, Michigan, has “done very well” because about half of its revenue comes from people replacing products.
Even so, there could be a “classic rotation” underway as investors look to other economically sensitive industries that are accelerating at this stage in the expansion, Manley said. As a result, the divergence in stock performance could last if higher mortgage rates make investors less enthusiastic about companies that build new residences, he said. The performance of these indexes has widened before, most recently in 2004 and 2005, when homebuilders outpaced home-improvement retailers.
With interest rates on mortgages tempering since September, the market is entering a period that’s historically favorable for the homebuilding index, Zener said. These stocks typically outperform the market in November-February, as “people get more optimistic that housing will improve in the spring.”
In addition, new-home construction has finally turned a corner and “once that takes place, you should expect it to be sustained,” Shaoul said. “These are long, multi-year cycles.”
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