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Homebuilders Showing Opportunity Despite Mixed Housing Data

The housing market has proven a tricky play for investors this year, with homebuilders still struggling despite a slew of headlines touting the market’s strengths. 

Home prices rose on a year-over-year basis in all 20 U.S. cities in a S&P Case-Shiller index, including more than 10% gains in Denver and San Francisco. The Ryland Group Inc. (NYSE: RYL)

Tuesday’s housing data also revealed that home prices declined on a -0.2% seasonally adjusted basis from June, a time when home prices traditionally rise.

Home prices are up about 5% from last year, according to the S&P/Case-Shiller home price index July data, missing analyst estimates for a 5.2% rise. While prices rose over the past year, many homebuilders stocks retreated.

Homebuilder stocks like PulteGroup (PHM) and Hovnanian Enterprises (HOV) are incurring losses, while recent economic indicators are hinting that the housing recovery is not yet on firm footing. PHM stock has dropped 12% this year, while HOV stock is down a staggering 57%.

Monday’s pending home sales data — one of the more telling indicators of future business — also pointed to a gloomier housing market outlook. August pending home sales index dropped 1.4% to 109.4 from 110.9 in July, slowing the annual growth rate from 7.4% to 6.1%.

Finally, existing-home sales also stalled in August after three straight months of gains, falling 4.8% to a seasonally adjusted rate of 5.31 million from 5.58 million in July. Year-over-year home sales were up 6.2% from the 5 million reported for August 2014.

Finding Opportunity in Homebuilders

Homebuilders have been struggling in recent months — the SPDR Homebuilders ETF (XHB) is down 0.5% year-to-date despite a 15% run in the past 12 months. It’s hard to say whether mixed housing data or broader volatility is the culprit.

Still, while the annual trend is still firmly toward higher price tags and more sales, investors may want to look more closely at some bruised stocks that could enjoy a rally if the market stabilizes.

Investors looking for the next hot homebuilders should tap into areas of the country already reporting the strongest growth — namely the West. For example, pending home sales were down 5.5% in the Northeast and 2.2% in the South, but they were actually up 1.8% in the West.

Two homebuilders — Los Angeles-based KB Homes (KBH) and Ryland Group (RYL), based in West Lake Village, Calif. — are best positioned to tap into the stronger pockets of housing demand.

KB Homes reported last week that its third-quarter sales soared 43% from a year prior with more delivery volume, but profits sank on increased land costs. CEO Jeffrey Mezger said in a statement the company is working toward improving margins and increasing operating leverage.

Ryland Homes, which reports Oct. 22, is up 5% for the year-to-date and up 22% in the past year.

One last economic factor that affects homebuilders: the Federal Reserve’s interest rates, which are expected to rise this year. Higher interest rates translates into a higher cost of buying for consumers, but Lawrence Yun, NAR chief economist, said he expects ongoing job growth will help counter more prohibitive rates.

“With job growth holding steady, prospective buyers can handle any gradual rise in mortgage rates — especially if today’s stronger labor market finally leads to a boost in wages and homebuilding accelerates to alleviate supply shortages,” Yun said in a statement.

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

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