Foundation Set for a Bottom in Homebuilders

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Key Conclusions:

  • Homebuilder stocks continue to advance despite underwhelming housing data. We suspect this represents price leading fundamentals.
  • While mortgage rates have receded over the last several months, housing starts and building permits have yet to improve. A recovery in the forward-looking building permits data would be a bullish sign for the sector and the broader equity market.
  • One area of housing data that may have bottomed is builder sentiment, which recently advanced after a 12-month losing streak last year. A bottom in builder sentiment has historically coincided with equity market bottoms.
  • The technical setup for homebuilder stocks remains bullish despite the underwhelming housing data. The Dow Jones U.S. Select Home Builders Index broke out from a bottom earlier this year and is now trending higher. We believe the rally has more room to run.

Housing market data and homebuilder stocks have diverged over the last several months. Rising interest rates and the subsequent spillover into mortgage rates poured cold water on the post-pandemic housing market melt-up. The national average 30-year fixed rate mortgage jumped from 3.27% at the start of 2022 to a multi-decade high of 7.35% in November. Housing prices dropped across the country, while groundbreaking on new homes and building permits plummeted, albeit from multi-year highs.

While mortgage rates, highlighted in the top panel of the chart below, have receded over the last several months, housing data has shown no signs of an inflection point. Housing starts, shown below in orange, fell 4.5% in January to a seasonally adjusted annual rate of 1.31 million, marking the longest monthly losing streak since 2009. The more forward-looking building permits data, shown below in blue, held steady last month as an uptick in multifamily permits offset a decline in the single-family category. The big question now is if mortgage rates have peaked, when will housing market data finally start to improve? The rally in housing-related stocks suggests a bottom could be near.

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A Bottom in Builder Sentiment?

One area of housing data that may be bottoming is builder sentiment. As a backdrop, the National Association of Home Builders (NAHB) Housing Market Index (HMI) declined for 12 straight months last year, as builders dealt with rising construction costs, cancellations due to affordability constraints, and snarled supply chains. However, the streak of deteriorating builder sentiment finally ended in January, and the NAHB HMI has now posted back-to-back monthly gains. The latest NAHB report released on Wednesday, February 15, noted, “While we expect ongoing volatility for mortgage rates and housing costs, the building market should be able to achieve stability in the coming months, followed by a rebound back to trend home construction levels later in 2023 and the beginning of 2024.” The chart below highlights the NAHB Index and its three components, which have all inflected higher near pandemic-era lows.

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What Does This Mean for Stocks?

A bottom in builder sentiment would be a bullish sign for stocks. Four of the five major bottoms in the NAHB HMI since its inception in 1985 occurred near market bottoms (2001 was an early signal).

Four of the five periods also overlapped with a recession. The exception was the bottom in 1995, which coincided with a Federal Reserve soft landing. The chart below highlights each period along with how the S&P 500 and homebuilder stocks performed after each major NAHB HMI low. Of course this data comes with the asterisk of limited occurrences and the benefit of hindsight in determining the NAHB HMI lows. Nonetheless, returns for both the S&P 500 and its homebuilding subindustry group are impressive.

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Finally, the technical setup for homebuilder stocks remains bullish despite all of the underwhelming housing data. As shown below, the Dow Jones U.S. Select Home Builders Index (DJSHMB) broke out from a bottom earlier this year and is now trending higher. Overbought conditions related to the breakout have eased, setting up a pullback opportunity at the uptrend support line. Relative strength for the index also remains bullish as the DJSHMB has been outperforming the S&P 500 since April 2022. While the DJSHMB has made an impressive comeback over the last several months, we believe the rally could continue back toward the 2021 highs near 14,900, representing nearly 20% of potential upside from current levels.

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Original articled post to LPL Research by Adam Turnquist, CMT, VP Chief Technical Strategist


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