Housing stocks just keep rallying. After a 2018 sell-off that saw the SPDR S&P Homebuilders ETF (NYSEARCA:XHB) fall more than 25% off its highs, housing stocks have bounced back in early 2019 amid a series of fundamental and technical improvements. Year-to-date, the Homebuilders ETF is up nearly 20%.
I’ve been bullish on this group of stocks for a few months now (see here and here). Coming into the year, I felt that there was nowhere for housing stocks to go besides up, and further thought that 2019 would be a breakout year for these beaten up stocks. So far, it’s been just that. Now, the big question is: will this rally in housing stocks continue?
I think so. I think housing stocks largely have 10% to 20%-plus upside remaining into the end of the year. If so, that would put housing stocks on track to have a 30%-plus up year in 2019.
What are the drivers behind this big 2019 housing stock rally? Let’s take a deeper look.
Reasons to Buy Housing Stocks: They’re Really Beaten Up
Coming into the year, housing stocks were in major sell-off mode. The Homebuilders ETF was 25% off its highs, while many individual housing stocks were much deeper in the red. LGI Homes (NYSE:LGIH) fell as much as 50% off its highs in late 2018. KB Home (NYSE:KBH), Toll Brothers (NYSE:TOL), Lennar (NYSE:LEN) and PulteGroup (NYSE:PHM) all dropped 30%-plus.
Such big sell-offs in housing stocks are usually buying opportunities. The last time you saw such a big downdraft in housing stocks was in early 2016. Before that, it was late 2011. Before that, the housing crisis. Each time, housing stocks proceeded to rebound from their big sell-off. This sell-off appears to be no different, with the bounce-back having already started.
Valuations Are Cheap
Even though housing stocks have broadly rallied 20%-plus in 2019, valuations across the board are still cheap. LGI Homes trades at under 8 times forward earnings. That seems to be about the norm for housing stocks these days. Alongside LGI Homes, home-builders KB Home, Toll Brothers, Lennar and PulteGroup all trade at single-digit forward P/E multiples.
Meanwhile, D.R. Horton (NYSE:DHI) trades narrowly above 10-forward earnings, and the most expensive home-building stock on my buy radar — NVR (NYSE:NVR) — trades at just 14 times forward earnings, and that’s still below the market average forward multiple. Across the board, then, housing stocks are still really cheap.
Housing Market Data Is Improving
Broadly speaking, U.S. housing market data has dramatically improved in 2019 after a slowdown in late 2018.
After tumbling to their lowest level in two years in December, housing starts jumped back sharply by nearly 20% in January. Home-builder confidence has likewise bounced back, and is now at multi-month highs. Months supply of homes has dropped back below 7, signaling that the market isn’t oversupplied and that demand remains steady.
Overall, U.S. housing market data has improved significantly in early 2019. These improvements indicate that 2019 should be a better year for home-builders than most expected a few months ago, and that rosier-than-expected outlook should keep housing stocks on an uptrend.
Mortgage Rates Are Falling
A big reason for the U.S. housing market turnaround is that financing costs for buying a home have dropped materially over the past few months.
Specifically, the Federal Reserve has gone from “let’s hike rates at all costs in 2018” to “let’s go neutral in 2019,” a sharp pivot which has caused a big and beneficial reversal in mortgage rates. In late 2018, 30-year fixed mortgage rates rose 50 basis points from 4.5% to nearly 5%. But, in early 2019, the 30-year fixed mortgage rate has dropped from 5%, to 4.3%.
That’s a 70-basis-point drop in mortgage rates, which is significant. That 4.3% rate is also the lowest the 30-year fixed mortgage rate has been in over a year. As such, with financing costs low and only going lower, buyers should keep coming back into the market.
The Job Market Is Solid
For the most part, consumers don’t buy houses unless they have jobs. They also don’t buy houses unless they are getting raises. But, when consumers have jobs and are getting raises, they tend to buy houses.
That’s exactly what is happening right now. Recent jobs reports have confirmed that the U.S. labor market remains very healthy. Specifically, the unemployment rate remains at record low levels, wage growth is hitting decade-high levels, and inflation is relatively contained, so real wage growth is very strong.
As such, Americans have jobs, and they are getting wealthier. So long as those things remain true, demand in the housing market will remain healthy.
Home Ownership Rates Are Low
A largely underrated yet important fact about the U.S. housing market is that, despite a strong economy, home ownership rates remain relatively depressed.
Specifically, the home ownership rate in the U.S. in the fourth quarter of 2018 was 64.8%. Back at its peak in 2004, home ownership rates were nearly 70%. Indeed, from 1995 to 2013, home ownership rates in the U.S. were consistently above 65%, or above where they are today.
The implication is that the U.S. housing market has room to grow under the right circumstances. If the economy keeps firing on all cylinders, if Americans stay employed, if financing costs remain depressed, and if wages keep going up, then the U.S. home ownership rate will naturally make its way from below 65%, to nearly 70%.
That move higher will provide a nice tailwind for housing stocks.
Millennials Are Finally Moving Out
One of the biggest narratives over the past decade has been that a surge in student debt has left recent college graduates both unable and unwilling to get a mortgage on a house. But, it appears that this narrative is finally changing course.
Over the past decade, the number of 18-to-34-year-olds living with their parents has been consistently on the rise, and hit 32% in 2016, versus a long term average of 28%. But, in 2017, that figure dropped to 31.5%, the first drop in several years.
If this trend reversal persists (and it should under the right circumstances), then demand in the housing market will naturally move higher over the next several quarters and years as Millennial buyers finally enter the market. As they do, depressed housing stocks should stay on a healthy recovery path.
As of this writing, Luke Lango was long XHB, LGIH, KBH and TOL.