A long-awaited rate cut seems certain to happen this week, but homebuilder stocks have been anticipating this moment since October 2023 when the Fed signaled that rate hikes were over. That leaves the group with little room for error, RBC Capital Markets said. Analyst Mike Dahl believes the stocks are “priced perfectly” as industry fundamentals remain shaky beneath the surface. He said stocks in the firm’s coverage “significantly outperformed expected interest rate cut gains, well beyond previous Fed cycles.” Still, Dahl expects Toll Brothers, Taylor Morrison Home and Tri Pointe Homes to outperform their peers. Toll Brothers shares are up 46% in 2024, Taylor Morrison shares are up more than 28% and Tri Point shares are up 25%. The S&P Home Builders ETF (XHB), which tracks the S&P 500 Home Builders Index, is up nearly 26% in 2024, rising over the past three months as signs of slowing inflation become more evident and investors take notice. 15%. XHB 1Y mountain Spdr S & P Homebuilders ETF over the past year. Over the past five Fed cycles, the average 12-month gain for homebuilder stocks covered by the firm has been just 4%, according to RBC data, while shares of building products companies have gained 15%. . Even in the mid-1990s, when the Fed orchestrated a “soft landing,” homebuilder stocks rose an average of 19%, according to Royal Bank of Canada. “We don’t know whether the initial rate cuts will trigger meaningful changes to a large extent (a deeper/faster rate cut cycle may indicate a more concerning fundamental backdrop),” Dahl said. The market is heading towards Tuesday’s Federal Reserve meeting. The Bank of China held a policy meeting and was confident in cutting interest rates, but the extent of the rate cut is still a controversial issue. Traders see a 59% chance of a 50 basis point rate cut, according to CME Group’s FedWatch tool. The probability of a 25 basis point rate cut has dropped to 41%. ‘Caution is warranted’ While markets are looking for more aggressive moves, many economists have been advocating for a more modest approach. One concern that could come with further rate cuts is that they suggest Fed officials are worried the economy is weakening rapidly. “Consumer/employment deterioration remains the key risk as equity performance has been binary in previous cuts cycles, depending on the success of cuts in averting a recession,” Dahl said. “We believe the overall group is on track Tactical caution is needed, but we think it makes the most sense for builders that are overvalued,” he said, citing Lennar and KB Home as two examples of potentially overvalued companies. Lennar shares are up more than 24% in 2024, and Dahl believes the stock is rich relative to return on tangible equity. KB Home shares are up 38% year to date, but most analysts have a hold or sell rating on the stock. Analysts expect KB Home shares could retrace more than 10% based on the average price target, according to FactSet. “We believe housing fundamentals will theoretically improve as interest rates continue to be benign, largely reflected in current valuations, while continued interest rate volatility amid mixed economic, inflation and employment data could This will create a volatile trading environment until market visibility becomes clearer. Barclays analyst Matthew Bouley is also watching the data closely and said much will depend on consumer sentiment on mortgages. Reaction to falling loan rates. “At current valuations, we believe homebuilder stocks are fully dependent on lower mortgage rates to drive continued improvement in housing fundamentals into 2025, while unemployment will not be the same,” he wrote on Tuesday. rise. “Lukewarm Housing Data” Bouley noted that inventory of both existing and new single-family homes is increasing, single-family housing starts are weak, and weekly mortgage applications are showing only modest improvement. But he is encouraged by the fact that New home sales improved in July, up 11% from the previous quarter and 6% from a year earlier, Pauley said, which is one of the clearest signs yet that the recent decline in mortgage rates is drawing buyers in. Market. Last week, mortgage rates hit their lowest levels since February 2023, meaning rates on traditional 30-year fixed-rate loans were nearly a percentage point lower than they were the same week a year ago. “Tactically speaking, housing data. Improvements in should support stocks, but the risk/reward balance has become more balanced,” Pauley said. This dynamic will ultimately benefit the larger builders, including behemoths like Dr. Horton. He said they are “more resilient relative to small/private builders because the ability to apply incentives and tap into larger geographic and buyer demographics should enhance demand and profit elasticity relative to macro trends.” In housing affordability Such incentives are important in an environment where competence remains a key issue. DR Horton shares are currently trading close to its average price target, according to FactSet. Slightly more than half of the analysts covering the stock rate it a “buy” or “overweight,” the report said.
Homebuilder stocks ‘priced to perfection’, investors need to see lower interest rates drive demand | Real Time Headlines
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