Is DHI’s Earnings Miss The Canary in The Coal Mine?
Shares of the largest homebuilder in the U.S., D.R. Horton (NYSE: DHI) got clobbered on 1/23/24 as the company failed to meet analyst expectations on its fiscal first quarter 2024 earnings. Central to the miss was a slowing in the company’s sales.
The key for investors is whether this signals that the housing market has finally hit the wall as the Federal Reserve’s record interest rate increases since 2022 have finally hit critical mass.
If true, then the Fed’s actions have now tightened the lending climate to the point which has reduced the potential number of homebuyers whereby even incentives and lower prices from homebuilders aren’t enough to keep the new home sales market’s steady growth afloat.
Rosy Outside but Darker Inside
At first glance, the report was quite positive, as the company delivered $947 million ($2.82 per share) in earnings with $7.7 billion in revenues (6% year over year growth) to go along with a rise in the number of homes closed and a rise in orders. These are numbers over which many companies in diverse businesses would salivate, especially the revenues which beat expectations. However, analysts expected $2.88-$2.89 per share in earnings.
So, it wasn’t a huge miss in earnings in the face of a revenue beat. That’s often a scenario which Wall Street forgives and at least delivers minimal losses for the stock. Yet, the stock got clocked.
The problem for Horton, seems to be that its order backlog of homes under contract shrunk by 11% and its unsold inventory is starting to climb with 730 completed homes sitting on lots for over six months. Moreover, the company only raised its forward guidance for FY 2024 minimally.
In other words, the business is starting to plateau; or it was doing so in the company’s FY Q1, which ended on 12/31/23. What makes that more concerning, though, is that bond yields were falling through that period in time. That suggests that the surge in buyers coming off the sidelines due to falling rates during the period might have been less than Wall Street estimated or what was reflected in the homebuilder sector’s stock prices.
The price chart is discouraging to say the least. The stock fell below the key support level of its 20-day moving average and may be headed for a test of the $140 price area, where the 50-day moving average may provide support.
The rest of the sector sold off in sympathy, but as we see in the shares of the SPDR S&P Homebuilders ETF (XHB), the sector as a whole sold off on the Horton earnings, but held up much better than DHI. This is a positive development in the short term. But this ETF bears watching as a break in its shares would indicate that the homebuilder sector’s nifty long term grind higher may be reversing.
Latest Inflation Data Will Set the Tone
January 25, 2024 could be a big day for bonds and stocks. Indeed, this week’s data releases have suddenly gained additional importance. The two major ones, GDP and the PCE inflation indicator will be the headliners.
The release of the latest U.S. GDP numbers, in which the housing sector accounts for 15-16% will cause bond market to react. Inside the GDP report traders will be watching the GDP Price Index figures. Meanwhile, the Fed’s favorite indicator, the Personal Consumption Expenditures Index (PCE) will also be released and will be closely watched.
Any negative surprises in those two numbers could well add to the housing sector’s problems as a rise in bond yields would lead to a rise in mortgage rates.
In addition, the latest batch of jobless claims, recent numbers of building permits, durable goods orders, retail inventories, and a host of regional Federal Reserve bank reports will be released. Lately, many of these indicators have offered a mixed picture of the economy.
Two recent examples of regional Fed bank reports, the Richmond Fed Manufacturing Survey and the Philadelphia Fed Services data showed contractions of economic activity combined with inflationary pressures in these regions. New orders and employment fell in Richmond, while wages climbed. In Philadelphia, prices for input prices increased while the whole index rolled over into contraction territory.
Online marketplace ebay Inc. (NSDQ: EBAY) and Alphabet (NSDQ: GOOGL) have recently joined the growing list of tech companies that have announced layoffs. As a result, bond traders will be looking for clues in the latest batch of figures. If data leans toward a weakening economy, expect a rally in bonds and a fall in yields. Hints of rising inflation will lead to the opposite.
What’s Next? Look to the Bond Market for Clues.
Much of what happens next depends on the economy, which is inextricably linked to what happens with the Federal Reserve and its closely related financial relative, the U.S. Treasury bond market. Specifically, housing is linked to the U.S. Ten Year Note yield (TNX), as its trend is directly tied to the trend of the U.S. mortgage market.
Lately, the bond market has been in a funk as the expectations for a full reversal of the Fed’s tight money policies had been priced in for March 2024. Of course, central bankers put a damper on those hopes after the December consumer price index (CPI) came in above expectations and reignited inflation fears.
Raising the uncertainty about future price increases is the developing situation in the Red Sea where Yemeni groups have been attacking merchant ships and have caused a major rerouting of traffic to the tip of South Africa whose additional distance is expected to cause delays in cargo deliveries and may extend into full-fledged, and possibly long standing supply chain snarls.
The U.S. Treasury note yield has been creeping higher since the CPI number was released, as several Federal Reserve speakers tamped down hopes of rate cuts in early 2024. TNX has backed up from its late December 2023 lows near 3.8% to the 4.1% area. What makes 4.1% crucial is that it corresponds to the 50-day moving average for TNX.
That means that large amounts of algorithmic trading programs are likely to be triggered to sell bonds, and likely stocks, if TNX breaches that level.
The most recent earnings report for the largest homebuilder in the U.S., D.R. Horton suggests that the steady growth in the new housing market is flattening out. On the other hand, there are no signs that the status of supply and demand for homes has changed. There is still plenty of demand for new homes and there aren’t enough homes on the market to accommodate this demand.
The problem is the Fed as the presence of high interest rates seems to have reached a point where even though there is an imbalance of supply and demand in the housing market, mortgage rates and the persistence of inflation are starting to flatten out the rate of growth for new home sales as consumers struggle under the multiple pressures of the situation.
In addition, even though it’s not reflected in the monthly payroll figures, companies continue to announce layoffs. A rise in unemployment would compound the potential problems for housing as fewer buyers qualify for mortgage loans even in a lower interest rate environment.
Bond traders are pulling back their horns and U.S. Treasury bond yields, which in turn set mortgage rates, are creeping higher. The latest batch of economic data, especially the inflation numbers inside of the GDP report and the Fed’s favorite indicator, the PCE index, will be crucial in determining what happens next.
I own shares in DHI as of this writing.
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