Don’t Seek Safety in Peripheral Housing Plays

by Daniel Putnam | July 18, 2013 9:51 am

If the multiyear boom in housing stocks runs out of steam[1], what does it mean for the countless secondary housing plays that have gone along for the ride?

While the early returns show a fairly benign market impact thus far, investors in housing-related shares need to be on alert.

Housing Stocks Slip From Their Highs

The recent spike in interest rates, together with data showing some cooling[2] in the U.S. housing market, has taken a toll on homebuilding stocks in the past two months.

Since its high-water mark on May 16, the iShares U.S. Home Construction ETF (ITB[3]) has shed 10.3%, with large industry players such as D.R. Horton (DHI[4]), Lennar (LEN[5]) and Ryland (RYL[6]) off more than 17% even after the modest recovery of the past few weeks. While investors who got in at the October 2011 lows are still deep in the black — ITB still is up over 116% in that interval — the recent pullback nonetheless represents a meaningful slowdown in the momentum of what had been one of the market’s hottest sectors.

Naturally, the status of the housing market has ripple effects far beyond the homebuilders, and nowhere more so than the stocks whose fortunes are most closely tied to new home construction — the suppliers of new-home components such as water heaters, roofing supplies, flooring and the like. So far, however, these stocks — while certainly weak — have held up relatively well compared to the homebuilders since the May 16 high:

Construction Suppliers Ticker Return, 5/16/13-7/16/13
Lennox International LII +5.9%
Mohawk Industries MHK +0.2%
Fortune Brands Home & Security FBHS -3.7%
A.O. Smith AOS -2.8%
USG USG -7.1%
Lumber Liquidators LL -2.6%
Masco MAS -7.1%
Leggett & Platt LEG -4.9%
Armstrong World Industries AWI -4.0%
Owens Corning OC -9.0%
Trex Co TREX -11.5%
Simpson Manufacturing SSD +9.4%
Average -3.1%

Retail-related secondary housing plays have performed even better. Led by outstanding gains for Restoration Hardware[7] (RH[8]) and Select Comfort (SCSS[9]) — though the latter was off considerably this morning — the group of stocks shown below have not only outpaced ITB, but they also have trounced the returns of both the broader market (+1.9) and the Consumer Discretionary SPDR (XLY[10], +4.3%).

Home-Related Retailers Ticker Return, 5/16/13-7/16/13
Select Comfort SCSS +25.0%
Bed Bath & Beyond BBBY +10.2%
Lowe’s LOW +2.4%
Williams-Sonoma WSM +6.7%
Home Depot HD +5.0%
Tempur Sealy International TPX -3.9%
Pier 1 Imports PIR -3.8%
Whirlpool WHR -5.5%
Aaron’s AAN +1.3%
iRobot IRBT +13.6%
Restoration Hardware RH +33.3%
Ethan Allen Interiors ETH -5.9%
La-Z-Boy LZB +14.3%
Helen of Troy HELE +17.9%
Average +7.9%

Intuitively, this makes sense. From an economic standpoint, one would expect that the results of such companies would experience a lag effect relative to the housing market. If a consumer buys a new home in June, he or she likely won’t be finished shopping at Bed Bath & Beyond (BBBY[11]) for many months after that. Also, many of these companies have a large international component that reduces their dependence on the U.S. housing market. So far, these factors have been borne out in market performance.

At the same time, it isn’t realistic to expect this divergence to continue for a significant period of time. And if homebuilding stocks resume their weakness, the peripheral plays will come under pressure.

In the past five years, the 12 stocks shown in the “suppliers” table have had a correlation of 0.86 with ITB, while the 13 retail stocks have registered a correlation of 0.73. Given that correlations run on a scale from -1.0 (perfectly inverse) to 1.0 (perfectly correlated), these numbers indicate that where homebuilders lead, the component and retail names are likely to follow.

The message here isn’t that the U.S. housing market is about to collapse. However, the relative weakness of the homebuilding stocks in the past two months indicates a distinct cooling of enthusiasm — a trend that is starting to be reflected in a softening of incoming economic data. Investors in the peripheral housing plays — many of which have already delivered outstanding gains in recent months and years — therefore should consider using any strength in these groups to cash in some gains rather than betting on a continued divergence.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

  1. runs out of steam:
  2. data showing some cooling:
  3. ITB:
  4. DHI:
  5. LEN:
  6. RYL:
  7. Restoration Hardware:
  8. RH:
  9. SCSS:
  10. XLY:
  11. BBBY:

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