Homebuilders remain in the driver’s seat as tight housing supplies linger. In fact, the housing market is so tight that nearly 80% of the sales closed in September were for homes which weren’t even finished. That means that the existing home market is at the point that buyers are willing to close deals and then wait for their home to be built.
That's very bullish for homebuilders over the long term. Yet, in this market the homebuilder stocks are amid a price correction. That's because investors are frightened about high interest rates.
So although I am long term bullish on the sector, in this article, I describe several important steps which should be taken prior to investing in their stocks.
The Current Market
First, let’s examine key components of the balance between supply and demand in the current housing market.
New home sales soared 12.3% in September as incentives from homebuilders and a decline in the median new home price continue to entice able buyers despite higher mortgage rates in a market where there is nearly no supply of existing homes;
The National Association of Realtors (NAR) recently reported that existing home sales fell by 15.4% year over year in September; describing the numbers as new cycle lows;
Pending home sales rose 1.1% on a month to month basis in September while remaining down 11% year over year. The Southern region remained the strongest pending sales region with an index reading of 87%, just 13 points below 100 which is considered neutral. The West registered a loss and remains in worst shape of all regions with a reading of 55.3%.
A deeper dive into the new home sales numbers shows that only 17% of the closed sales were for homes which were finished and move in ready; 59% of the homes sold were in some phase of construction and 24% were purchased before construction started.
The bottom line is that, as I’ve been saying for quite some time, there aren’t enough existing homes on the market, which means that the supply and demand balance is, by necessity, leaning toward the homebuilders. Moreover, there are no emerging signs which suggest the situation is going to change until interest rates decline.
Winners and Losers as Mortgages Break to New Highs
As the U.S. Ten Year Note yield (TNX), the benchmark for most long term mortgages continues to rise, so have mortgage rates.
You can see the aggressive trajectory of rates in mortgages (MORTGAGE) closely mirrors the rise in TNX.
In addition, the price chart below for the SPDR S&P Homebuilders ETF (XHB) shows the generally negative effect of the rise in rates on the homebuilder stocks.
On the other hand, the damage to XHB is nothing compared to the damage which higher mortgage rates have caused in the real estate brokerage sector, which specializes in existing home sales. You can see the huge losses registered in the shares of broker Re/Max Holdings (RMAX) whose stock price has been cut in half over the last nine months.
Analyzing Whether to Buy or Sell Homebuilder Stocks
The price chart for XHB is not totally indicative of what’s happening in the shares of individual homebuilders. That’s because XHB’s portfolio includes building material and related companies whose fortunes are often out of sync with homebuilder stocks. In this market, the best chances of success are likely to be realized by owning individual homebuilder stocks. But in order to maximize potential gains, investors should have a plan before they buy.
As a result, before making buy or sell decisions, it makes sense to look at individual homebuilder stocks as opposed to the entire industry. Here’s an illustrative example, homebuilder KB Home (KBH). This is not a buy or sell recommendation on the stock. It should be taken only as an illustrative example of how to proceed when currently evaluating entrance into homebuilder stocks.
As the price chart illustrates, shares of KBH have fallen 20% in response to higher mortgage rates. That’s not exactly a good price run; but it’s less than half of what Re/Max has experienced. Moreover, while Re/Max is well below its 200-day moving average, KBH is slowly building a base just below its 200-day line.
KBH is slowly developing what will hopefully be reliable support at $42, the lower end of a large Volume by Price bar (VBP). Remember, large VBP bars are highly reliable support and resistance levels. That means that prices that rise or fall above these price points will likely trend in the direction of the break.
So, the first step is to see if KBH Holds at $42. The next test will be what happens at the 200-day moving average if $42 holds. If KBH rallies and holds above the 200-day moving average, this would be an excellent price area to enter the stock.
Here is something else which is encouraging. Accumulation/Distribution for KBH is in a mild down trend as short sellers are trying to push the stock lower. But On Balance Volume (OBV) is very steady which suggests that buyers are not panicking.
Incidentally, I have recently recommended five homebuilder stocks and their exact entry points at Joe Duarte in the Money Options.com, which you can access via a Free Two-Week Trial to the service here.
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