Housing Equities: A Better Trading Vehicle Than Buy-and-Hold Investment
- By John Tierney
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- 3 min read
Housing activity softened in February, with existing home sales down 6.6% and new home sales down a sharp 18.2%. This was largely attributed to harsh weather in February that, among other things, caused massive and prolonged power failures in Texas. We will not quibble with that explanation – but we also suggest other things are occurring that indicate a moderating pace of home sales activity in 2021.
It was more than just weather. Housing starts were only down 8.2%. New home sales data reflect when sales contracts are signed. Sales often happen before construction starts, in an office or over the telephone – activities much easier to do in bad weather than building houses. It appears that the pace of new home buying is indeed slowing.
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Summary
- Home sales dropped sharply in February largely due to weather, but we think there is more to it.
- Housing sales are moderating due to tight inventories, rising rates and home prices, and an unwind of pent-up demand after the 2020 lockdowns.
- We see housing returning to pre-pandemic trends in coming months.
Market Implications
- Robust housing demand has been highly supportive of homebuilder-related equities, but at this juncture we think they are priced for perfection.
- Housing equities may be an attractive trading vehicle in 2021, but over the medium term they are unlikely to outperform the broader market.
Home Sales May Moderate in 2021
Housing activity softened in February, with existing home sales down 6.6% and new home sales down a sharp 18.2%. This was largely attributed to harsh weather in February that, among other things, caused massive and prolonged power failures in Texas. We will not quibble with that explanation – but we also suggest other things are occurring that indicate a moderating pace of home sales activity in 2021.
It was more than just weather. Housing starts were only down 8.2%. New home sales data reflect when sales contracts are signed. Sales often happen before construction starts, in an office or over the telephone – activities much easier to do in bad weather than building houses. It appears that the pace of new home buying is indeed slowing.
Inventory is tight! For various reasons related to the ongoing pandemic, inventory of houses for sale – whether new or existing – are at or near 20-year lows. A homeowner may sell easily, but buying another house is tough or there is a long wait to move into a new house. In short, tight inventory will limit potential sales activity in coming quarters.
Costs and prices are rising. Rising costs may start to weigh on home-buying decisions. Lumber prices have nearly doubled over the past year. Lumber accounts for 15-20% of the cost of a new house, so this has kept pressure on home prices that may in turn dampen some enthusiasm for new homes.
And mortgage rates are rising. In early 2021, the Freddie Mac Survey rate was 2.7%; it is now 3.1% (Chart 1). The spread to the 10-year Treasury was 140 basis points. A more normal level is about 175 basis points, so mortgage rates could easily rise further even if the 10-year Treasury stabilizes near 1.7%. This should not have a major impact on housing activity, but it is a headwind.
Payback time continues. Last but not least, we think the 2020 surge in new and existing home sales was largely payback after sales collapsed in the spring of 2020 during lockdowns (Charts 2 and 3). We expect home sales will settle near pre-pandemic trends in coming months.
All things considered, we rate the outlook for housing in 2021 as solid but unspectacular.
Equities Priced for Perfection Again
Turning now to equities, homebuilder-related stocks have had a great run since the 2020 March low (Chart 4). We create three groups of equities: homebuilders (DHI, KBH, LEN, PHM, TOL),[1] two homebuilder ETFs (ITB, XHB), and two homebuilder-related retailers (HD, LOW) that are often included in homebuilder ETFs. The idea is to compare pure-play homebuilders and homebuilder retailers with the ETFs. Clearly, all three groups have been more volatile than the broader S&P 500. But relative to year-end 2019, they have outperformed by more than 20 percentage points. The pandemic surge in housing activity and home remodelling has clearly been a major factor.
Entering the early March selloff, we opined that housing-related equities were priced for perfection. Indeed, they sold off considerably more than the broader market – but then recovered nicely.
We still believe homebuilders are pricing in much good news. While housing market may remain healthy, homebuilders face pressure on several other fronts. A combination of rising rates and input costs may limit the ability to pass on costs, hurting margins. Limited inventory, especially for existing homes, may limit new home demand. And, as the economy reopens during 2021, people may start directing their disposable income more toward travel and entertainment rather than home improvements.
Homebuilders may be attractive as a short-term trading vehicle at this juncture, but over the medium term we do not expect them to continue to outperform the broader market.
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DH Horton (DHI), KB Homes (KBH), Lennar (LEN), PulteGroup (PHM), and Toll Brothers (TOL). ↑
Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)