Homebuilders Leading U.S. Consumer Stocks: EcoPulse
Shares of U.S. homebuilders are leading consumer discretionary stocks as the new home market is poised to rebound faster than other cyclical purchases this year.
The Standard & Poor’s Supercomposite Homebuilding Index -- made up of Toll Brothers Inc. (TOL), NVR Inc. and nine others -- has risen 20 percent since Nov. 11. The S&P 500 GICS Consumer Discretionary Sector Index -- which includes Lennar Corp. (LEN), PulteGroup Inc. (PHM), D.R. Horton Inc. and 81 other companies such as Home Depot Inc. and Lowe’s Cos. -- is up 1.9 percent during the same period. This follows about 10 months when homebuilders lagged behind by 45 percentage points.
Shares of companies that construct new residences are a source of relative strength in what’s proven to be a “more difficult market” this year, as the S&P 500 slid almost 6 percent in less than three weeks, said Michael Shaoul, chairman and chief executive officer of Marketfield Asset Management LLC in New York, which has more than $20 billion in assets. The recent rally in homebuilders suggests “a very important transition of leadership within the consumer discretionary sector” is underway, benefiting this segment of the broader cyclical group, he said.
After several years of confidence in other areas of discretionary spending -- including retailers -- the rebound in shares of homebuilders signals investors are anticipating a stronger spring selling season, Shaoul said. That would be welcome news because purchases still are “well below” their historical average, he said.
New home sales, at a 414,000 annualized pace in December, have rebounded about 46 percent since July 2010 though they trail the 692,000 average since 1980, based on figures from the Commerce Department.
Sales of existing single-family residences have risen almost 41 percent from a July 2010 low to a 4.3 million annualized rate in December, above a 34-year average of almost 3.9 million, according to data from the National Association of Realtors. Similarly, purchases of new cars, at a 15.2 million annualized rate in January, have surpassed the 14.5 million average since 1980, based on figures from researcher Autodata Corp.
January sales figures for existing homes are scheduled to be released Feb. 21, followed by data for new homes on Feb. 26.
It’s taken longer for new homes to rebound in the economic expansion that began in June 2009 than in previous ones. Shaoul expects sales will pick up this year because “it’s almost impossible to continue this economic cycle without a significant recovery in the new home market.”
Housing purchases -- and homebuilding stocks -- fell in the summer amid rising mortgage rates, though both have since rebounded as financing costs have moderated again, said John Manley, who helps oversee $233.6 billion as chief equity strategist for Wells Fargo Funds Management in New York.
It would be very unusual for sales to significantly weaken at this stage of the recovery, particularly with interest rates near record lows, Manley said.
After rising to a two-year high of 4.67 percent in September, the average fixed rate on a 30-year mortgage has moderated to 4.25 percent as of Feb. 11. “Rates going back down a little bit has helped these stocks,” Manley said.
Relative to the broader consumer discretionary group, the homebuilding index broke a downtrend late last year as investors began allocating more money to these stocks, said Jim Stellakis, founder and director of research at Greenwich, Connecticut-based research company Technical Alpha Inc.
Shares of the homebuilders are approaching a “key resistance level” -- relative highs set in 2012 and 2013 -- and if surpassed, it will indicate “a bigger positive shift in sentiment,” he said.
In addition, NVR (NVR), based in Reston, Virginia, and Standard Pacific Corp. (SPF), based in Irvine, California, are among builders that reported strong earnings in the past three weeks, beating the consensus of analysts’ estimates. Toll Brothers, based in Horsham, Pennsylvania, is scheduled to release first-quarter results Feb. 25. The same day, home-improvement retailer Home Depot will report fourth-quarter numbers, followed by Lowe’s on Feb. 26.
Some companies reported rising gross margins in their most-recent results, which have been a positive catalyst for investor sentiment, said Kenneth Zener, an analyst in San Francisco at Keybanc Capital Markets Inc.
He cites Bloomfield, Hills, Michigan-based PulteGroup and D.R. Horton, in Fort Worth, Texas, as two such examples. This shows profitability wasn’t hurt when demand was thrown off in the second half of 2013, in part because of rising interest rates, he added.
Orders per community -- an industry measure of demand -- fell 23 percent in the three months ended Sept. 30 from the prior quarter for seven of the publicly-traded homebuilders, compared with a historic average of minus 12 percent for that quarter, Zener said, citing data he collects. These orders improved slightly in the fourth quarter, falling 9 percent, compared with a historic average decline of 14 percent for the period, Zener’s data show.
While there’s some “natural volatility” in these orders, some of the demand that was lost in the quarter ending in September was pushed into the most-recent period, Zener said.
That’s because mortgage rates still are low by historic standards, so would-be buyers jumped back into the new home market after rates stabilized in the fall, Shaoul said. Recent earnings from the publicly-traded homebuilders showed demand for housing hasn’t collapsed, as some investors feared when speculation about the Fed’s plans to taper its monetary stimulus program intensified beginning in May, he added.
The pause in activity was directly related to the higher cost of financing, Federal Reserve Chair Janet Yellen said in her Feb. 11 testimony to the House Financial Services Committee. “The recovery in the housing sector slowed in the wake of last year’s increase in mortgage rates,” she said.
Even so, new construction is exhibiting seasonal trends, though cyclical growth is needed for the stocks to continue to outperform their discretionary peers, Zener said. Investors already have taken into account that orders per community will rise about 35 percent in the first quarter from the prior period, on pace with historical trends, he said, and larger gains are needed to attract additional investment.
Zener downgraded MDC Holdings Inc. (MDC) and D.R. Horton last month to hold recommendations from buy in part because their stocks are fully valued. The industry usually trades between 1.5 times and 2 times book value and these companies were trading at the high end of that range, he said. He maintains buy recommendations on Toll Brothers and Miami-based Lennar.
Even if new construction doesn’t return to pre-recession highs soon, housing is such an integral piece of spending that consumers -- and investors -- will “come back to the well again,” Manley said. “It’s not as if this part of the economy will go away.”
Many potential buyers are finding better deals for new homes because the inventory of existing structures in some markets is “getting very tight,” while prices are “no longer a bargain,” Shaoul said. The median price of an existing house rose 9.9 percent to 198,000 in December from a year earlier, marking 22 consecutive months of gains, according to data from the National Association of Realtors.
What’s more, the stock performance of homebuilders, relative to other discretionary categories, shows that investors, including Shaoul, have renewed confidence in further improvements.
As a result, “the beginnings of the second leg to the recovery of the U.S. new-home market” could be underway, he said. “Investors are betting the new home market recovers faster as the economic expansion evolves.”
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