After a blistering 18-month performance, housing stocks have weakened and look to continue underperforming.
Housing stocks were one of the best-performing sectors of the overall market throughout 2012 and the first quarter of 2013, as the real estate market caught some tailwinds thanks to low interest rates, low prices, and a paucity of inventory. However, the sector as a whole has completely stalled since mid-May. While the S&P 500 has climbed 8.3% since May 15, the S&P SPDR Homebuilders Index (XHB) has actually lost 3.2%.
While some builders, like Toll Brothers (TOL) have only suffered moderate losses, the performances of several other builder stocks have been dismal. Lennar (LEN) has been sliced from $44 to $34.17, KB Home (KBH) has dropped from $25 to $16.75, Hovanian Enterprises (HOV) is down from $6.00 to $4.94, and D.R. Horton (DHI) has been hammered from $27 to $19.60.
The XHB, while underperforming the market, is at least doing better compared to those stocks. That’s because the fund has been held up by good performances from stocks that benefit indirectly from the housing market such as Lowe’s (LOW) and Whirlpool (WHR).
A number of factors have contributed to the decline of the individual housing stocks over the last 6 months, including lofty P/E ratios, higher interest rates, the government shutdown and a drop in consumer confidence.
How will the housing stocks perform in 2014, and will they continue to lag the broader markets? I believe the answer to the latter could be yes. Unless conditions change radically, there are five factors that should continue to limit the performance of housing stocks over the next six to12 months:
A rise in the number of listed properties: Abnormally low inventory levels boosted prices throughout 2012 and part of 2013. However, inventories are beginning to rise. The National Association of Realtors (NAR) reported that inventory levels of unsold homes rose in September from a year earlier, the first rise in inventory since 2011. Many homeowners who previously were upside down on their mortgages and unable to sell are no longer under water, as their home values have risen while reducing further loan principal. As a result, more seller-owned homes will be listed for sale, and higher inventory levels should weigh more on demand next year.
The release of shadow inventory: In areas where foreclosures were the highest, like Nevada, California and Florida, banks are now beginning to release more of their foreclosures after holding them back for years in order to stabilize prices. Lower-priced foreclosures, especially on homes built between 2001 and 2008, offer a much cheaper alternative to buyers than new homes, even after factoring in the cost for repairs and cosmetic improvements to the home.
Weak job creation: Unemployment is still high at 7.3%, and many of the average monthly jobs being created recently are merely part-time or service industry jobs with low wages that are not conducive to growing home ownership. In fact, home ownership rates have continued to decline in recent months. Some younger consumers are also shunning home ownership, and are inclined to view renting as a more flexible and favorable life style. Newer apartment complexes often cater to these consumers whims with in-ground pools, fitness rooms, bike trails, etc. People pay more to have these benefits, but seem unwilling to trade them for the lawn mower and backyard barbecue lifestyle of home ownership.
Rising interest rates: The decline in housing stocks over the second half of 2013 is directly attributable to talk of the Fed Tapering its monthly purchases of bonds, and the resultant rise in interest rates that it produced. While no set decision has been reached regarding how and when the Fed will begin to taper off on its purchases, it would cause a sharp rise in interest rates in 2014. The one-two combination of rising rates and home prices could land a knock-out punch to homebuilder stocks.
Healthcare costs: With the shaky roll-out of Obamacare, there is a great deal of uncertainty among consumers as to how much they will have to pay for health insurance and medical costs. As young consumers in the 27 to 39 year old age group begin to pay more for health care, it will reduce the amount of money available to them to save for housing related down payments and closing costs. This, more than any of the other factors mentioned, could put a serious crimp into home sales in 2014.
With all of the uncertainty surrounding the housing market, I believe the housing stocks will continue to underperform the general market in 2014, and I would not buy these stocks at their current levels. With a difficult real estate market ahead, it would not surprise me to see many of these stocks drop another 15% to 20%. For those who are still inclined to have a small portion of their portfolio in housing stocks, XHB will offer a safer and less volatile alternative to the individual builder stocks.
As of this writing, Ethan Roberts did not hold a position in any of the aforementioned securities.