At the start of this week, we learned that new home sales fell 0.3% in February to a seasonally adjusted annual rate of 662,000 units. That is roughly 2% less than the 675,000 figure that Wall Street was expecting.

Also, the median price for a new home sale in February was the lowest it has been in over two years. Combined, those two data points might suggest that the housing market is slowing down.

Wall Street doesn’t seem to think so. This week, premium homebuilder Toll Brothers (NYSE: TOL) hit a new all-time high above $128.

That’s good news for my PF Pro subscribers. I recommended the stock to them two years ago while TOL was trading below $58.

Most of that gain has occurred since late October. Over the past five months, TOL is up 86%. Over the same span, the SPDR S&P 500 ETF Trust (NYSE: SPY) has returned 26%.

It is no accident that TOL is performing so well. Now that the Fed is done raising interest rates, lower mortgage rates should increase demand for new homes.

In fact, that may explain why new home sales in February came in lower than expected. Why get a big mortgage now when mortgage rates may be lower in a few months?

At this month’s policy meeting, the Fed did not say when it would start cutting interest rates. However, it did say that it expects to reduce its policy rate by 75 basis points (three-quarters of a percentage point) over the remainder of this year.

Mixed Messaging

When I recommended Toll Brothers to my readers in February 2022, the outlook for homebuilders was bleak. At that time, the Fed was preparing to raise interest rates to drive down inflation.

Also, supply chain disruptions due to the coronavirus pandemic extended delivery dates for new homes and pushed up prices. When Toll Brothers released its fiscal 2021 Q4 and full year results that month, it acknowledged those problems.

At the same time, it reiterated its guidance for 20% revenue growth in 2022. Despite that reassurance, Wall Street bailed out of homebuilders believing many potential buyers would hold off until the economy was back on firm footing.

I said then, “Wall Street has a bad habit of overreacting to language that is anything other than unabashedly optimistic. In this case, I do not believe that Toll Brothers is trying to signal that bad news about the current year is on the way. If it were, then it would have also revised its guidance for sales revenue, which it did not.”

I went on to state: “Instead, I think the company is saying that some sales that would have closed this quarter may get pushed back to the next quarter. If so, then the recent drop in TOL’s share price presents a buying opportunity.”

Now, I’m wondering if the opposite is true. Just as Wall Street tends to overreact to bad news, it can also get carried away with unbridled optimism.

Certainly, Toll Brothers isn’t doing anything to quell that sentiment. When the company released its fiscal 2023 Q4 and full year results last month, it raised its fiscal 2024 guidance for all its major operating metrics.

Sell on the News

There is a saying on Wall Street: “Buy on the rumor, sell on the news.” In other words, get in front of the curve by anticipating how the stock market will react to a future event.

Two years ago, I might have been the only stock market analyst recommending Toll Brothers. While everyone else was bailing out, I was buying in.

But now that everyone else is buying in, I think it may be time to bail out. Sooner or later, some reversion to the mean will be in order.

By the way, I made money on that with Toll Brothers, too. But that time, I was expecting a very different reaction from Wall Street.

In June 2021, I recommended to readers of my Mayhem Trader service that they buy a put option on Toll Brothers. A put option increases in value when the price of the underlying security goes down.

At that time, the inflation news was starting to get bad. I figured that would drive down homebuilder stocks, so I made my move the week before the previous month’s Consumer Price Index (CPI) numbers were released.

My hunch proved correct. Those figures came in higher than expected and TOL took a dive. In just one week, my put option tripled in value!

I don’t expect that to happen this time. But I do think buying a put option on TOL could be a smart move. Especially if you already own the stock and want to protect your big gain.

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