BackHigher Rates Catch Up With Home-Builder Stocks
The home-building industry had been one of the stock market’s best performers of the year until recently.
PremiumThe rally in home-builder stocks has finally fizzled.
The SPDR S&P Homebuilders exchange-traded fund has fallen about 9% this month, compared with a 5.2% decline for the benchmark S&P 500. Shares of PulteGroup, Toll Brothers and KB Home have slid more than 10% in September.
The home-building industry is one of the most sensitive sectors to changes in interest rates, yet until recently it was one of the stock market’s best performers for 2023. That is because higher mortgage rates forced many homeowners to stay put, leading to a dearth of houses for sale and fueling the need for newly built homes.
As some of the froth comes out of the broader stock market, investors and analysts say the higher costs to buy a home are finally starting to take a toll on the shares. Despite the recent slump, PulteGroup is up about 60% in 2023, Toll Brothers is up 45%, and KB Home is up 40%. The S&P 500 is hanging on to an 11% advance.
Mortgage rates peaked at 7.23% in late August, the highest level since 2001, and are still hovering above 7%, according to the latest weekly reading from Freddie Mac. They tend to move loosely with the 10-year Treasury yield, which on Tuesday hit its highest level since 2007. Some investors expect yields to keep climbing as they brace for the possibility that interest rates remain higher for longer.
“Home builders are at the mercy of the Fed," said Michael Cook, investment analyst at Penn Mutual Asset Management.
The broader stock market’s rally has stalled since the end of July, with a flurry of stronger-than-expected economic data raising worries about the path of interest rates. The S&P 500 on Friday closed out its worst week since March after the Federal Reserve left rates unchanged but signaled it could raise them once more before year-end and keep them elevated in 2024.
Traders in the interest-rate derivatives market have repeatedly pushed back their expectations for when the Fed will start cutting rates—they currently put about 45% odds on the prospect of lower rates by June.
Frank Memcaj, founder of Wayman Value Investing newsletter, said Americans might hesitate to buy a home if they expect rates to soon fall.
“Where we’re at in the rate hike cycle, this is when it starts to change buyer sentiment and behavior," Memcaj said.
Recent data is also casting doubt about whether home-builder shares can hold on to their outsize gains. Housing starts in the U.S. slid 11% in August to the lowest level since June 2020. New-home sales suffered their largest monthly decline since September 2022, while existing-home sales, which make up most of the housing market, fell to their slowest pace since January.
“We’re finally starting to see the reaction that most people had expected, which is [share] prices starting to come down," said Chris Zaccarelli, chief investment officer for Independent Advisor Alliance.
Some analysts and home builders expect the market to improve over time, given the country’s tight housing supply. Last week KB Home reported a quarterly drop in profit from a year earlier, but raised its revenue and earnings outlook for its fiscal year ending in November.
“The outlook remains healthy for housing market conditions driven by low existing home inventory and constrained availability of new homes at our price points," Chief Executive Jeffrey Mezger said on the company’s earnings call.
Despite this year’s run-up, housing stocks are still trading at cheaper valuations than their historical averages. PulteGroup, Toll Brothers and KB Home are all trading at about six times their projected earnings over the next 12 months, below their 10-year average of roughly 10. The S&P 500’s multiple is about 18.
Write to Hardika Singh at hardika.singh@wsj.com
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