Homebuilders: A Case of Too Far, Too Fast

by Dan Burrows | July 25, 2013 12:23 pm

If the housing market is doing so great, then why have the big homebuilders’ stocks been so bad lately?

After all, on Wednesday we learned that new home sales jumped 35% year-over-year to hit a level last seen in 2008.

And yet, individually and as a group, homebuilders are seriously underperforming the S&P 500 this year — and have done so with nasty, pull-defeat-from-the-jaws-of-victory volatility.

The short answer is that the market looks to have gotten ahead of itself after an insanely hot run.

PulteGroup (PHM[1]), the biggest U.S. homebuilder by market capitalization, helped drag the sector lower Thursday after posting some disappointing quarterly results. Earnings missed Wall Street’s average forecast, while orders for new houses fell short of what many analysts were looking for too.

At the same time, shares in D.R. Horton (DHI[2]) likewise dropped sharply after earnings. The No. 3 homebuilder by market value beat the Street’s profit estimate, but revenue failed to hit analysts’ projections.

And yet results from both companies weren’t nearly as bad as the steep selloffs would have you believe. Pulte’s underlying business is still strong, for one thing, and D.R. Horton beat estimates in part with a 74% jump in gross profit on home sales.

By the same token, however, the news out of the housing market isn’t uniformly great either.

The latest reading on existing home sales was disappointing, revealing a month-to-month dip in June. We also just learned that the median price for a new home fell 5% in June vs. May. Perhaps most importantly, the spike in mortgage rates has builders, banks and the market worried about future demand.

Now, against that backdrop, consider how far and how fast homebuilder stocks rose last year through the spring, and you can see why the market is being totally unforgiving of anything that misses expectations or offers the slightest whiff of weakness.

The iShares US Home Construction ETF (ITB[3]), which counts Pulte, D.R. Horton, Lennar (LEN[4]) and Toll Brothers (TOL[5]) among its top holdings, soared an astounding 78% in 2012.

Cut to 2013. Have a look at this year-to-date chart comparing ITB with the broader market, and you’ll see just as astounding volatility:

ITB CHART Homebuilders: A Case of Too Far, Too Fast[6]

ITB was up as much as 23% in early May. It’s also swung down to no more than a single-digit-percent gain five times. One way to think of this action in the ETF and the underlying homebuilders is that they keep getting priced for absolute perfection — a case where nothing on the earnings and data fronts can go wrong.

Indeed, even having everything go right wouldn’t be good enough.

When the market gets this high and heated, anything less than a steady stream of data that beats expectations is going to spark pullbacks and selloffs. The momentum, the paper profits and stretched valuations make traders primed to hit the exits (if only because they know everyone else is, too).

Yes, the housing recovery looks like it’s for real — but the market figured that out more than a year ago.

As of this writing, Dan Burrows didn’t hold a position in any of the aforementioned securities.

Endnotes:
  1. PHM: http://studio-5.financialcontent.com/investplace/quote?Symbol=PHM
  2. DHI: http://studio-5.financialcontent.com/investplace/quote?Symbol=DHI
  3. ITB: http://studio-5.financialcontent.com/investplace/quote?Symbol=ITB
  4. LEN: http://studio-5.financialcontent.com/investplace/quote?Symbol=LEN
  5. TOL: http://studio-5.financialcontent.com/investplace/quote?Symbol=TOL
  6. [Image]: http://investorplace.com/wp-content/uploads/2013/07/ITB-CHART.jpg

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