Homebuilder Stocks Will Rally If Three Things Happen
Editor’s Note: The author of this article, Dr. Joe Duarte, has been a professional investor and independent analyst since 1990. He is a former registered investment advisor and author of the bestselling Options Trading for Dummies, and several other books including Market Timing for Dummies and Successful Biotech Investing. He’s also a medical doctor. This month, after a hiatus, Dr. Duarte returned to the Investing Daily team.
Homebuilder stocks may be gearing up for a late fall run in 2021, unless, of course, rising mortgage rates and falling stock prices spook potential homebuyers.
The traditional mantra for real estate investors is “location, location, location.” But in the age of social media and the inter-related markets and the economy complex (what I call the MELA system), a new battle cry can be heard from homebuyers: “low mortgage rates, and higher stock prices = new house.”
In our digital world, social media and the rapid dissemination of information allows prospective homebuyers to discern when it’s a good time to buy or not to buy. These decisions are based on readily available mortgage quotes and rapid analysis of the real estate market via highly sophisticated web sites such as Zillow.com, in turn supported by social media.
The upshot is that because of the interconnectedness of the MELA system, home sales respond almost immediately to rising or falling mortgage rates, and the effect cascades through the system.
You can see this connection in the above chart, courtesy of the Federal Reserve of St. Louis:
- Rising home sales (upper blue line);
- Rising S&P 500 (middle red line); and
- Falling mortgage rates (lower green line).
As the chart sugggests, home sales are a direct function of both falling mortgage sales as well as the “wealth effect” created when stock prices rise.
Accordingly, if the trends seen on the FRED chart above hold to their historical tendencies, homebuilder stocks may get a late year rally as long as mortgage rates remain stable and stock prices rise.
Long-Term Trends Favoring Homebuilders Remain in Place
As I noted in my recent note on Ethan Allen Interiors (NYSE: ETD), the fundamentals for the housing market have not changed after the COVID-19 exit from big cities. Indeed, they have evolved as some people are returning to large cities due to lower rents and falling home prices that resulted from the pandemic. Two macro constants in housing that have not changed:
- Tight supplies, and
- Stable to rising demand.
Just to be clear, no matter where people are moving, there still aren’t enough houses available at a time when demand remains high. As long as the stock market rises and mortgage rates remain stable or fall, homebuilders remain in a favorable position.
Fear of Missing Out
Specifically, this potential rally in homebuilder stocks seems to have already started and may gather steam. That’s because prospective buyers who may have missed out on prior opportunities may finally take that leap as they gauge the effect of those relatively low mortgage rates on their chances to buy a house, and the positive effect of rising stock prices on their 401k plans while adjusting their spending habits accordingly.
This is evident in the price action for the SPDR Homebuilders ETF (XHB), an exchange-traded fund (ETF) that contains both homebuilder stocks as well as shares of crucial housing subsector companies such as security systems, building materials and companies that specialize in component installation and related niches.
The above price chart shows a consolidation pattern over the last six months with price resistance just below $80. During this consolidation period, we’ve seen homebuilders deliver above average gains as well as positive guidance on their earnings reports. Interestingly, this positive vibe in the sector has been met with skepticism by traders, and thus we see the sideways price action.
That perception, however, could be changing as the Accumulation Distribution (ADI) and On Balance Volume (OBV) indicators have bottomed out and turned up. This signals that money is moving into XHB.
Of course, the real test will be what happens at the $80 area. If XHB can break out convincingly, it will signal that the good times may be once again rolling for homebuilders.
But before we break out the champagne, it may be a good idea to see what happens to the stock market if and when the Fed actually starts to taper its quantitative easing (QE) and how the bond and mortgage markets respond. Even though the supply and demand fundamentals for homebuilder stocks remain very attractive, just as location is everything for real estate, remember that timing is everything for stocks and ETFs.
But perhaps making a bet on the ups and downs of the housing sector isn’t for you. If you’re looking for new growth opportunities with less risk, consider the advice of my Investing Daily colleague Jim Pearce. Perhaps you know Jim from his stewardship of our flagship publication, Personal Finance.
Jim Pearce has devised market-beating methodologies in his new trading service, Personal Finance Pro. Want to take investing to the pro level? Learn more here.