The bad news keeps coming for the housing market and the wall of worry keeps rising. This morning’s existing home sales came in slightly above forecast, but were down year over year by 0.7% according to the National Association of Realtors. Other recent data, as I describe below, was even worse.
But here’s the thing, the bad news from the month of May is so bad that it may well be signaling a potential washout in sentiment, which of course is often the prelude to a rebound.
On the ground, in real time, two things are evident. Mortgage rates are below 7% for the third week running. And guess what? As I’ve been expecting, the market timers are waking up. I’m seeing buyers slowly moving into new homes.
That was Then
Much of the bearish tilt on the housing market of late has been based on data from the month of May, which is old news. And since a lot’s happened in the world of interest rates in the last six weeks, the old data is misleading.
Let’s start with the recently published data from online broker Redfin, which reported that “home sales had their worst month ever,” in the month of May, as record housing prices, persistently high mortgage rates, and low housing supplies combined to keep both buyers and sellers off the market. Meanwhile, housing starts – both single and multifamily – also fell in May, the lowest level since April 2020, at the start of the pandemic. These reports go along with the above cited existing home sales data.
Times are Changing
Certainly, those are cautionary numbers. Yet, the data reflects the month of May, where mortgage rates were well above 7%. As the chart below shows, mortgage rates have fallen below 7% since the start of June and barring a major reversal in bond yields, will likely put a floor under the bearish sentiment.
Regular readers shouldn’t be surprised at the bad data. As I recently wrote, the market’s sentiment has been dour for several weeks. Specifically, I noted:” thanks to higher interest rates, walking through a new housing development these days is like walking through a graveyard,” while adding “the current and highly unnatural lack of activity, is giving me a bad case of the contrarian collywobbles. The disconnect between the apparent lack of interest from buyers, the lack of bullish action in the homebuilder stocks, and, the apparent lack of interest exhibited by some realtors in the face of the supply and demand imbalance and the ongoing demographic shifts suggests that when the dam bursts, the results will be nothing short of spectacular.”
Getting Granular
I don’t want to come off as a housing perma-bull. But I also don’t want to miss an opportunity to make big money on the housing sector. Thus, it’s important to sort through the important factors which are interacting in the current market:
· Supply and demand – Tight supplies remain in place, which means that once interest rates fall, the potential for a rush of new buyers into both new and existing homes will likely materialize;
· Interest rates - Don’t look now, but as I point out below, mortgage rates have just dropped for the third straight week;
· Demographic shifts – The population shifts to the Southern U.S. remain in place and will likely continue, especially if the economy continues to slow.
What the homebuilders are saying
Perhaps what’s most important is what the homebuilders are saying in their earnings calls. For example, leading national homebuilder Lennar (LEN), a personal holding, and a long term holding in the Rainy Day Portfolio at Joe Duarte in the Money Optinos.com, recently beat its earnings expectations handily, while offering a flat outlook based on interest rates. As the price chart shows, the market was unimpressed.
On the other hand, the stock remains above key support as value investors seem to be buying on the dip.
Indeed, a deep dig into the earnings call shows that Lennar, along with other builders are managing their inventories by building only as many houses as they sell and by keeping the backlog stable. The company is also full of cash on its balance sheet and it’s using the cash to buy back stock and to pay down debt. It’s also forging off balance sheet partnerships with private equity companies to share potential future risks.
In other words, LEN, and most homebuilders learnt their lesson from 2007 and are now well funded risk managers. Moreover, by holding inventories steady – having enough houses and lots on hand to meet steady, but not overwhelming demand – the company is setting up for the next up wave in the cycle, which should develop once mortgage rates show a steady decline.
Rates Drop for the Third Straight Week
So now it gets interesting. The average 30-year mortgage just fell to 6.87% - down over half a point from where it stood in early May when the market dried up. Now, unless bond yields rise unexpectedly, it’s just a matter of time before we see at least some buyers come off the sidelines.
This is especially likely once the crowd realizes that the lower rates drop, the lower will be the likelihood of incentives from builders. And with prices at all time highs, many are likely to think it’s now or never.
For its part, the U.S. Ten Year Note yield (TNX), the benchmark for the average 30 year mortgage retains a bullish tone, trading below its 200-day moving average. Moreover, there is enough economic data accumulating now, especially on the employment front, which suggests that the economy is slowing, a fact that helps keep bond yields from climbing.
The homebuilding sector, as in the iShares U.S. Homebuilding Construction ETF (ITB) remains in a consolidation pattern. This reflects the notion that longer term investors are patiently waiting for the clarion call of interest rates which will likely precede the next rally in the sector.
Meanwhile, the rental market remains stable. The iShares U.S. Real Estate ETF (IYR) is holding steady in response to lower bond yields.
I’ve just added a new homebuilder to my portfolio; a company with excellent management and a pristine balance sheet which offers the perfect geographical and demographic setup for a big move when the market turns. You can review it with a FREE Two Week Trial to Joe Duarte in the Money Options.com.
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