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Tread Lightly into This Sector

The housing market enters a recession … don’t expect prices to drop much … checking in on our ITB homebuilders trade … be wary in the short-term

While there’s debate about whether the economy is in a recession, there’s one sector that officially fits the bill…Housing.From Robert Dietz, Chief Economist at the National Association of Home Builders (NAHB):

Tighter monetary policy from the Federal Reserve and persistently elevated construction costs have brought on a housing recession.

Yesterday, we learned that the National Association of Home Builders/Wells Fargo Housing Market Index dropped 6 points this month to 49. The index has now seen eight straight monthly declines.The word “recession” comes into play due to the sub-50 reading. Anything about 50 is positive, anything below is negative.This negative reading is the first one since the start of the Covid pandemic. Prior to that, there hasn’t been a negative reading since June 2014.Meanwhile, this morning we learned that U.S. homebuilding fell to the lowest level in nearly one-and-a-half years. Housing starts dropped 9.6% to a seasonally adjusted annual rate of 1.446 million units in July. That’s the lowest level since February 2021.Buyers are staying on the sidelines for one reason: astronomical prices.From CNBC:

The biggest hurdle for buyers right now is affordability.Home prices have been climbing since the start of the pandemic, and the average rate on the 30-year fixed mortgage, which had hit historic lows in the first part of the pandemic, is nearly twice what it was at the start of this year.

Recession or not, don’t expect a crash in home prices

Would-be homebuyers are responding to record-high home prices and 5%+ mortgage rates by walking away from the market.Econ 101 tells us that “less demand” should reduce prices. And yes, we’re seeing some softer prices in various markets around the country.But if you’re waiting for the price-tag on your dream home to crash, say, 30%, good luck with that. You see, in the same way that many buyers are now walking away from the table, so too are sellers.According to a new report from Redfin, an increasing number of homeowners are simply holding off on putting their home on the market. This is fueling the largest decline in home listings in more than two years.In fact, new listings of homes for sale dropped 12% year-over-year during the four weeks that ended Aug. 7. That’s the steepest drop-off since June 2020.Meanwhile, the latest Home Purchase Sentiment Index from Fannie Mae shows that the share of homeowners who believe now is a good time to sell is dropping. In May, that reading was 76%. Last month, it was down to 67%.Simply put, owners are backing away from deals too. So, if both buyers and sellers are dropping out of the market, then the relationship between supply and demand isn’t changing dramatically.Now, the good news for homebuyers is that overall housing continues to grow modestly. The number of homes for sale is up 4% year-over-year.More encouraging is that the number of home-offers written by Redfin agents that faced competition from other buyers was down to 44% in July. That’s the sixth-straight monthly decline and the lowest share on record. In June the number was nearly 51%. In May, it was almost 64%.But looking big-picture, the national housing inventory remains near historical lows. And that means there are still more people wanting homes (at reasonable prices) than there are homes available.

Recent data show why housing prices will take a breather but not crash

Back in mid-June, the median home sale price hit a record high of $395,500. Since then, prices have declined 4.1%.And how have prospective homebuyers responded to these modestly lower prices?Well, the Google search “homes for sale” is up 12% since late-May.We see a similar tick-up in buying interest if we look at the seasonally adjusted Redfin Homebuyer Demand Index. This is a measure of requests for home tours and other home-buying services from Redfin agents. It’s up 17% from mid-June.The bottom line is that prices might drop some, but don’t expect a crash. There are too many would-be homebuyers watching from the sidelines, waiting for the slightest whiff of a reasonable price.Here’s how Bankrate Chief Financial Analyst Greg McBride recently put it:

While the recent pace of home price appreciation isn’t sustainable over the long run, that doesn’t mean prices are at risk of a sharp drop.Real estate prices can move in big spurts — like now — and then show relatively little change over a period of years.A plateauing of prices is the more likely outcome.

And, in fact, over the last month, about 19% of homebuilders reported reducing prices to boost sales. But the median price reduction comes in at just 5%.

So, what does this mean for homebuilder stocks?

Well, clearly there are short-term headwinds facing the sector.High prices and mortgage rates are scaring away many buyers… months of high commodity prices have made building more expensive… the threat of a recession is making homebuilders nervous about the financial shape of buyers in the months ahead…But at the end of the day, the U.S. needs more housing inventory. That’s bullish in the long-term for homebuilders, despite the headwinds.Plus, if inflation data continue to show signs of cooling, it will take pressure off mortgage rates. That will add even more support on the demand side, which will be a boost to homebuilders and their stock prices.Back to NAHB Chief Economist Dietz on this:

The total volume of single-family starts will post a decline in 2022, the first such decrease since 2011.However, as signs grow that the rate of inflation is near peaking, long-term interest rates have stabilized, which will provide some stability for the demand-side of the market in the coming months.

So, how are these conflicting pressures playing on with homebuilding stocks?Below, we look at the iShares Home Construction ETF, ITB. It holds many homebuilding heavyweights including D.R. Horton, Lennar, PulteGroup, Home Depot, Toll Brothers, Sherwin-Williams, and Lowe’s.As you can see, after puking in June along with the broader market, it’s been in rally mode.

Chart showing ITB's stock price puking in June but rallying hard since
Source: StockCharts.com

Back in our April 20 Digest, we suggested that aggressive traders could jump into an ITB trade. The idea was that sentiment had grown so negative, and the sector had sold off so much, that any good news could send the ETF higher.ITB did climb higher following that Digest, only to sell off with the rest of the market in June. However, given the rally since then, that aggressive ITB trade is up now about 4%.

If you didn’t get into the ITB trade months ago, be careful about buying in today

Below, we look again at ITB’s chart, but we add its RSI indicator.RSI stands for “Relative Strength Index.” This is a momentum indicator that measures the extent to which an asset is overbought or oversold.Below, notice that ITB’s RSI has been trending down over the last few weeks at the same time that ITB’s price has been trying to climb higher.

Chart showing ITB stock increasing while its RSI begins to decrease in a bearish divergence
Source: StockCharts.com

This divergence is bearish.It suggests that the bullish leg higher is weakening, and the ETF is potentially on the edge of a bearish reversal. That could mean more attractive-entry prices in the near-future.That said, beyond the potential for short-term declines, we like the homebuilder trade for aggressive investors willing to take on a bit more risk. And we’re not the only ones.From Invezz:

New home sales have reached a bottom, which makes now a perfect time to go shopping in the construction space, says John Lovallo. He’s a Senior Equity Research Analyst at UBS.[Quoting Lovallo] “Homebuilders have been saying they’re seeing early signs of stabilization. Can homebuilder stocks work before rates change? It’s an early sector and the worst seems to be priced in. So, my answer is, yes, they can.”

Bottom line: On the other side of this shorter-term weakness in housing and home construction is a profit-boom. It’s not too soon to get your gameplan ready.We’ll keep you updated here in the Digest.Have a good evening,

Jeff Remsburg


Article printed from InvestorPlace Media, https://investorplace.com/2022/08/tread-lightly-into-this-sector/.

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