Why are homebuilding stocks losing relative strength with the lowest interest rates in the history of capitalism?
The group’s relative strength has been in a three-year downtrend.
The following article was originally published in “What I Learned This Week” on July 21, 2016. To learn more about 13D’s investment research, please visit our website.
This is a classic anomaly that we have used successfully for decades to attempt to find the truth about markets and the economy. Along with auto sales, housing has been an important component of the U.S. economic recovery and this is well worth studying. It is also meaningful that institutional investors are pulling back from the housing market. With mortgage rates near multi-decade lows, record-high household net worth and unemployment below 5%, homebuilders should be enjoying the best of times, yet the group’s relative strength has been in a three-year downtrend.
Our concerns regarding consumer confidence and the overall direction of the economy are underscored by the technical action of the homebuilder group over the past three years. The first of the following two charts shows that the ratio of the SPDR S&P Homebuilder ETF (XHB, $35.60) to the SPDR S&P 500 ETF (SPY, $217.09) remains about one-fifth below its early 2013 highs, despite the fact that the average 30-year fixed mortgage rate has fallen back to the 3.4% area — about where it was in early 2013 (as shown by the blue line in the second chart that follows). Even more disconcerting is the fact that the relative strength of the XHB has remained below its falling 200-day moving average in spite of the broader equity market recovery and the fact that the Fed has backed off its hawkish interest rate stance — two things that would normally translate into higher confidence for homebuilders.
The XHB’s underperformance is likely to continue, even though the Commerce Department, earlier this week, reported that housing starts rose at a better-than- expected 4.8% in June, to a seasonally-adjusted annual rate (SAAR) of 1.19 million units. The headline gain, however, masked the deteriorating fundamentals underneath: 1) the May 2016 gain was revised downward, from 1.16 million to 1.14 million units (SAAR); 2) building permits — an indicator of future construction activity — trailed housing starts, growing only 1.5% to 1.15 million units in June; and 3) housing starts fell 2% year-over-year and building permits fell 13.6% year-over-year in June, even though mortgage rates were over 50 basis points lower. The following chart illustrates the deteriorating trends in housing starts and permits.
Institutional buyers — considered the “smart money” — are also pulling back.
According to data from RealtyTrac, institutions accounted for 2.5% of all home purchases in June, down from a peak of nearly 10% in February 2013, as shown in the following chart. RealtyTrac’s Senior Vice President, Daren Blomquist, made the following comments to Bloomberg: “Their analytics are telling them it’s not a good time to buy — that’s definitely another red flag that they’re pulling back at the same time as the less savvy investors are ramping up.” Not surprisingly, the peak of institutional activity, on a relative basis, occurred around the same time that the XHB was near its post-recession high relative to the S&P 500.
In WILTW May 26, 2016, we pointed out that more Americans in the 18 to 34- year old age group were more likely to be living with their parents (32.1%), the highest percentage since the 1930s, as opposed to living with their spouse or partner in a separate household (31.6%) — the unfortunate result of too little high-wage job creation and too much student loan debt.
This trend suppresses the demand side of the housing market, while the supply- side has been hindered by builders eschewing starter homes and moving up the value chain, as evidenced by the fact that the average size of a new single- family home is almost 2,700 square feet today, versus less than 2,100 square feet a quarter century ago. Lennar CEO, Stuart Miller, recently gave a little insight into this supply shortage, telling CNBC: “When you start with a high land basis [cost] it’s very hard to end up with a purchase price that the first-time buyer finds affordable.”
Permit delays are also contributing to slower homebuilder supply growth. Ralph McLaughlin, chief economist at real estate tracking firm, Trulia, recently elaborated to The Wall Street Journal, as follows: “Ultimately what really matters for builders, what really impacts them, is this delay. If builders know that it’s going to take them a year to a year-and-a-half, and they think there will be downturn in that time, they’ll just say ‘We’re not going to build.’”
Single-family housing starts are almost 30% below the 30-year average. Not surprisingly, the inventory of homes that are owner-occupied peaked in the fourth-quarter of 2006 and has fallen 2.5% since then—despite 30- year mortgage rates being cut nearly in half—while the inventory of renter- occupied homes has grown 24%, as shown in the following chart.
Therefore, the XHB ETF could remain an absolute and relative underperformer for the balance of this year, at the very least. The lowest interest rates in the history of capitalism have done nothing to alter the decade-long decline in owner-occupied housing, so we have no reason to believe that even lower rates will alter this trend. On the other hand, a spike in interest rates could hurt housing affordability for entry-level buyers at a time when the supply of starter homes has been suppressed.
The longer-term economic implications of this analysis go far beyond homebuilders. Home equity has long been recognized as an important wealth- building tool for the middle class, though this process usually took place over decades (aside from the pre-2007 housing bubble). To the extent that a smaller percentage of young adults are able to begin building home equity now, then wealth inequality is likely to worsen over the next decade or two, adding to the list of headwinds to economic growth.
This article was originally published in “What I Learned This Week” on July 21, 2016. To subscribe to our weekly newsletter, visit 13D.com or find us on Twitter @WhatILearnedTW.
