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How High Can Homebuilders Go? (XHB)

Uptrending new home sales and strong seasonality are just two industry tailwinds

It’s springtime, and you know what that means. The birds are singing, the daffodils and tulips are blooming and homebuilders are swinging their hammers, which is great for the industry.

Just like the rest of the market, homebuilder stocks have enjoyed a fantastic rise during the past month. Looking at the exchange-traded fund SPDR S&P Homebuilders ETF (XHB) in Fig. 1, you can see that the fund has risen from a low of $28 to a recent high above resistance at ~$33.50.

How High Can Homebuilders Go? (XHB)

Fig. 1 — SPDR S&P Homebuilders ETF (XHB) Daily Chart

The question now is, does it have the potential to continue moving higher?

We think the answer is yes, and that is due in large part to the Federal Open Market Committee (FOMC).

FOMC Statement

At the conclusion of its most recent meeting on March 16, the FOMC released its monetary-policy statement. Here is the last paragraph from that statement (emphasis added):

“The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.”

In other words, the Fed is going to continue buying mortgage-backed securities (MBS). But how much is the Fed going to spend?

As you can see in Fig. 2, the Fed is currently holding $1.763 trillion (yes, that’s trillion with a “T”) in MBS, and it has commitments to buy an additional $17 billion worth.

Fig. 2 — Commitments to Buy Mortgage-Backed Securities

Fig. 2 — Commitments to Buy Mortgage-Backed Securities

Knowing that these are just the Fed’s current commitments (more purchases are sure to follow), and knowing that there are other investors out there competing with the Fed to buy these MBS, it tells us that demand for MBS in the future is going to be strong.

So how is this demand going to be met? Banks are going to find people to give mortgages to so they can then roll those mortgages into MBS and sell them to willing buyers, like the Fed.

Mortgage Demand

The Fed has done quite a bit during the past few months to help boost mortgage demand. Its easy monetary-policy rhetoric has helped to push the yield on 10-year Treasuries back down toward recent lows. As you can see in Fig. 3, the 10-year Treasury Note Yield is back below 2%.

Fig. 3 — 10-Year Treasury Note Yield (TNX) Weekly Chart

Fig. 3 — 10-Year Treasury Note Yield (TNX) Weekly Chart

The TNX is important because it directly influences the interest rate that financial institutions will charge for mortgages. The lower the TNX, the lower the interest rate on mortgages will be. The lower the interest rate on mortgages, the higher the demand for those mortgages is likely to be.

Demand for mortgages is also likely to increase thanks to easing lending standards.

Senior Loan Officer Opinion Survey on Bank Lending Practices

The Fed regularly surveys banks to see how their businesses are doing and to learn about what changes they see coming. It then releases its findings in the Senior Loan Officer Opinion Survey on Bank Lending Practices.

Two questions from that survey are important to our discussion. Here’s the first:

“Over the past three months, how have your bank’s credit standards for approving applications from individuals for mortgage loans to purchase homes changed?”

The table in Fig. 4 illustrates how the loan officers responded.


Fig. 4 — Three-Month Change in Credit Standards on GSE-Eligible Loans (Senior Loan Officer Survey)

As you can see, the trend during the past three months has been for banks to start easing their lending standards, which makes it easier for potential home-buyers to get a mortgage.

So what do loan officers expect for the coming year? Here’s the second question:

“Assuming that economic activity progresses in line with consensus forecasts, how does your bank expect the following lending practices and conditions for GSE-eligible residential mortgage loans to change over 2016 compared to current practices and conditions, apart from normal seasonal variation?”

The table in Fig. 5 illustrates how the loan officers responded.


Fig. 5 — Expected Change in Credit Standards on GSE-Eligible Loans (Senior Loan Officer Survey)

As you can see, loan officers expect more easing, which will make it all the easier for potential home buyers.

New Home Sales

With lower interest rates and easing lending standards, we anticipate that the housing market is going to have a solid year in 2016.

Last week, the Census Bureau released its New Home Sales number, and it came in at a strong 512,000. Looking at the chart of new home sales in Fig. 6, you can see this month’s number fits right in with the strong uptrend we have seen during the past few years.

Fig. 6 — New Home Sales

Fig. 6 — New Home Sales

We expect even higher numbers as we move into spring and summer.

Homebuilders are in a strong position. Seasonally, we’re heading into the strongest part of the year for home sales and, fundamentally, low interest rates and easing lending standards should continue to drive demand from first-time home-buyers, those looking to upsize and those looking to buy second homes.

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