Home ownership is out of reach for most Americans … the lowest housing inventory “ever recorded” … how this is a massive tailwind for homebuilding stocks … our ITB trade is up 40%

 

The housing market is out of whack.

As you can see below, the average 30-year fixed-rate mortgage has surged from about 2.50% at the beginning of 2021 to nearly 6.70% as I write Friday morning.

That’s a cool 150% markup in your financing costs.

Over the same period, the cost of the average U.S. home as measured by the Case Shiller Home Price Index has exploded 23%:

Here’s Fox Business News from Wednesday on these price increases:

Home prices across the U.S. increased by 0.7% annually in March, down from the increase of 2.1% in February, according to CoreLogic’s S&P Case-Shiller index. However, on a monthly basis, home prices grew 1.3% from February on an unadjusted basis…

The 10-city and 20-city composites saw gains of 1.6% and 1.5%, respectively, on a month-to-month basis.

Yesterday brought some encouraging news. Average home prices dropped sharply in May – down 3.1% from a year ago. That’s the largest year-over-year drop since 2011.

While that’s great, this price-decline is beginning from such an elevated level that home prices remain out of reach for many would-be homebuyers.

Plus, this is a national average. When we look at specific regions, we still see pockets of climbing home prices. For example, in the Northeast, home prices rose 2.5% from a year ago, and in the Midwest they’re up 1.1%.

So, what do you get when you combine a 150% increase in mortgage rates and a 23% increase in home prices in about two-and-a-half years?

An American housing dream on life support…and the mother of all tailwinds for homebuilding companies.

Would-be homebuyers are increasingly shut out of the housing market

As to the American housing dream, here’s MSN:

The lack of homes for sale continues to plague the housing market.

Buyers searching for that perfect house found fewer options last month as the number of listed homes dropped to a record low.

According to Redfin, just under 1.4 million homes (seasonally adjusted) were on the market in May. That’s the lowest level of inventory ever recorded by the real estate brokerage since it started keeping track of this data in 2012.

For a bit more context, when we compare today’s housing inventory level to that of May 2019, we’re now down almost 40%.

And digging into the numbers, the situation is even worse for the average new homebuyer. That’s because when we segment the housing market according to affordability, the shortage of available starter-homes is even more pronounced.

From Yahoo! Finance:

While 51% of earners in the nation make $75,000 or less, only 23% of available home listings are affordable for these households, according to a report published by the National Association of Realtors and Realtor.com…

…Higher-income folks have more options in their income bracket. While only 7% of households make $250,000 or more, they can afford 85% of listings shown…

In 2018, nearly 50% of home listings were affordable for families in the $75,000 income bracket, according to statistics provided by the National Association of Realtors. That number slowly declined — with the exception during the 2020 pandemic — to 23% in April 2023, when it was more than halved.

Why is the housing situation so imbalanced?

Well, the problem has been brewing for many years as supply has consistently trailed demand. So, the sector already faced a structural problem. But beyond that, record-low mortgage rates back in the pandemic resulted in a buying frenzy that depleted the housing inventory even more.

And now, given the run-up in interest rates, homeowners don’t want to sell. They’re sitting pretty on dirt-cheap mortgages, with no incentive to wade back into a market with new mortgage rates at nearly 7%.

But while this is awful for would-be homebuyers, it’s amazing for homebuilders.

“Homebuilders are all smiles right now”

That’s the headline from HousingWire.com on Monday.

Here’s the article:

For the first time in nearly a year, homebuilder confidence moved into positive territory thanks to strong consumer demand, limited competition from the existing home sales market, and an improving supply chain.

The National Home Builders Association‘s June survey marks the sixth straight month that builder confidence has increased and is the first time that sentiment levels have surpassed the midpoint of 50 (out of 100) since July 2022. The score in June was 55, up five points from May.

Basically, with record-low levels of existing-home inventory on the market, and precious few homeowners willing to sell, new homes are the only game in town. And homebuilders are reaping major profits.

As one illustration, last month, homebuilding giant Toll Brothers reported that its earnings grew more than 50% in the second quarter.

But you don’t have to be a homebuilder to have a smile on your face…

If you’ve been in our homebuilder trade, you’re also all smiles

In our April 20, 2022, Digest, we suggested that aggressive investors could jump into an iShares Home Construction ETF (ITB) trade. ITB holds homebuilding heavyweights including DR Horton, Lennar, NVR, Pulte, and Toll Brothers.

Our trade suggestion was due to the potential for major, multi-year gains we see coming after the market bottomed from recent basement prices.

Here was our disclaimer from that Digest about our timing and the potential for further volatility:

If you’re an aggressive trader who doesn’t mind the possibility of being early and sitting through some sideways (or even down) action, this is a reasonable entry point.

Reviewing this trade now, it was indeed a reasonable entry point.

Below, you can see ITB falling further after our April Digest as we warned, but then rallying hard.

An aggressive trader who took this ITB position would be up 40% right now, crushing the S&P which is down 2% over the same period.

If you jumped into this trade based on our recommendation, congrats and keep holding. The same tailwinds that have driven prices higher for more than a year are still in place today.

If you’re considering ITB today, keep an eye on its Relative Strength Index (RSI) level

As we profiled in Wednesday’s Digest, the RSI is a momentum indicator that measures the extent to which an asset is overbought or oversold. A reading over 70 suggests an asset is “overbought” (which increases the odds of a mean-reversion pull-back) while a reading below 30 means it’s “oversold” (which increases the odds of mean-reversion gains).

Traders often reference a stock’s RSI as a way to help time entries and exits.

As you can see below, ITB’s RSI just stuck a toe into overbought territory, coming in at nearly 71 as I write Friday morning.

To be clear, a stock can continue climbing after reading such stretched RSI levels. But traders should treat these situations with greater caution. A review of ITB’s price-action after hitting overbought RSI levels this year provides us more context.

Let’s begin with what happened in early-February. That’s when ITB’s RSI level pushed past 70 into overbought territory. As you can see below, the ETF quickly reversed, dropping from about $73 to roughly $66, or nearly 10%.

The second time ITB reached overbought RSI conditions was in mid-April. As you can see below, this time, the ensuing price drop was far milder, roughly 3%.

The third time was in May, when the RSI just barely touched 70. However, that pullback in ITB’s price registered about 6%.

As you can see from the charts, ITB has been flirting with overbought conditions for a couple weeks now. So, if you want to jump into the trade, just be aware there’s an elevated potential for a better entry price in the coming days.

Bigger picture, however, the structural imbalances in the housing market will continue to support profits for homebuilding companies in the coming months.

Until the Fed begins cutting rates, which translates into much lower mortgage rates that lure homeowners back into the market, inventory will remain near record lows. So, would-be homebuyers will have little recourse other than to look to new construction. Invest accordingly.

We’ll keep you updated here in the Digest.

Have a good evening,

Jeff Remsburg