Home Builder Stocks Are Way Down. A Calmer Bond Market Could Help.

September’s housing market data was ugly, and the continued deterioration in home sales and construction have taken a toll on home builder stocks.

Large builders such as



D.R. Horton

(ticker: DHI),



Lennar

(LEN),



NVR

(



NVR

), and



PulteGroup

(PHM) are down an average 35% so far this year. The S&P 500 has declined about 21%.

In the near-term, expectations regarding the Federal Reserve’s monetary tightening is likely to remain consequential for builder stocks. The central bank is expected to raise key interest rates by 0.75 percentage point and debate the size of future increases at their meeting in early November, the Wall Street Journal reported Friday.

“​​Investors are looking for a point in time when the Fed is slightly less aggressive—not accommodative, not neutral, but slightly less aggressive,” says Carl Reichardt, a BTIG analyst covering home builders, adding that Fed press conferences, statements, and minutes will continue to be focal points for investors in the sector.

Improvement in industry-specific metrics such as orders will also be key to builder stocks, he adds. “If a builder’s orders are down 50% [and] the next quarter they’re only down 20%, that’s improvement,” Reichardt says. 

Sales of existing-homes in September were 23.8% below the same month last year, the National Association of Realtors reported Thursday, while the government’s count of single-family housing starts and permits fell to their lowest levels since the early months of the pandemic. 

As housing activity has pulled back, so has builder sentiment. The National Association of Home Builders’ index tracking builder confidence dropped to its lowest level since 2020 in October, the trade group said on Tuesday. 

All signs point to a continued slump. Home loan applications, a leading indicator of home sales, have continued to pull back, with the volume of home purchase applications during the second week in October 38% below year-ago levels, according to the Mortgage Bankers Association.

Two indicators of September contract signings due this week, the government’s new home sales data and the National Association of Realtors’ pending home sales index, are expected to fall from August levels, according to FactSet consensus estimates. 

The pullback is expected to weigh on sales into 2023.



Freddie Mac

on Friday said it expects home sales in 2023 to decrease to 5.1 million from an anticipated 5.8 million this year, while house prices are expected to dip 0.2%.

“As housing market activity continues to contract, we expect a gradual increase in the supply of homes available for-sale, as compared to historically low levels last year,” Sam Khater, Freddie Mac’s chief economist, said in a statement. “The combination of much lower demand and higher supply will cause home prices to decrease during the next year.”

Last week’s home sales and construction data didn’t shake investors, says John Lovallo, a UBS analyst who covers builders and home building-related companies. “The bottom line is that activity has moderated, and that’s no surprise to the market,” Lovallo said.

Movements in builder stocks have recently been more aligned with changes in Treasury yields, said BTIG’s Reichardt. “Right now, the stocks are really caught up in the maelstrom of what the 10-year Treasury yield does, and therefore, really caught up with what the Fed is going to do,” Reichardt said. 

While the 10-year Treasury yield gained last week, exchange-traded funds that track the industry, such as the


SPDR S&P Homebuilders

exchange-traded fund (XHB) and the 


iShares U.S. Home Construction

exchange-traded fund (ITB) fell between Monday’s open and Friday’s close.

The connection comes down to home financing costs: The 10-year yield is a closely-watched indicator of mortgage rates, which have also gained significantly this year as the Fed has tightened monetary policy to fight inflation. 

The average rate on a 30-year fixed-rate loan last week was 6.94%, the highest in 20 years, according to a weekly Freddie Mac survey. Those gains have chipped away at would-be buyers’ bottom lines and stilted housing market activity and home price growth. 

“Rising mortgage rates always pulls home sales down,” Lawrence Yun, the National Association of Realtors’ chief economist, said during a call with reporters last week. At last week’s average mortgage rate, a buyer purchasing a $400,000 home would owe nearly $750 more a month than if they had bought at the end of 2021. 

Mortgage rates typically move similarly to the 10-year Treasury yield—but factors unique to the mortgage-backed securities, or MBS, market have recently made the spread between the two wider than usual, says BTIG mortgage analyst Eric Hagan. 

As part of the Fed’s monetary tightening, the central bank has stopped buying mortgage-backed securities. “There are no buyers for agency MBS with the Fed having stepped back from the market,” Hagan said. Commercial banks, he added, have also pulled back. Fewer investors in agency mortgage-backed securities means less liquidity in the secondary market and, for consumers, higher mortgage rates. 

Volatility is also a factor for investors in the interest rate-sensitive industry, says UBS’s Lovallo. “Once rates stop moving 15, 20 basis points a day in either direction, I think folks will start feeling a lot more comfortable that the bottom is near,” says Lovallo, who has Buy ratings on a number of builders including



D.R. Horton
,



Lennar
,



PulteGroup
,



KB Home

(KBH),



Meritage Homes

(MTH), and



Toll Brothers

(TOL). “When that happens, look out: these stocks are going to take off.”

Write to Shaina Mishkin at shaina.mishkin@dowjones.com

Source