The 2020-2021 surprise leap in new home sales ignited optimism among homebuilders. The increased sales combined with rising prices made for wonderful earnings and cash flow. So, what's a developer to do? Why, buy properties and build, of course.
The proof of that optimistic strategy is in the abnormally high inventory of unsold homes. The overbuilding began 2-1/2 years ago in March 2022. This graph shows how the usual 6-month inventory expanded. Currently, it is 27% higher than normal - a hefty cash commitment that carries a sizable risk of having to mark down prices in the future to reduce the overage.
So, why the optimism? The 2020-2021 sales bulge, along with expectations of the Federal Reserve reducing interest rates. The problem is that the 30-year and 15-year mortgage rates historically do not follow Fed-managed short-term rates. The same holds true for the much-watched 10-year US Treasury bond rate. And that is what the media is now writing about now - that the long-term rates are reversing direction and rising. Why the rises? Wall Street is seeing higher US Government deficits and borrowing ahead, along with the Federal Reserve now making money "easier." Because those actions can boost inflation, long-term rates are under pressure even as the Fed lowers short-term rates.
Then, there is that inflation effect which boosted prices, including for houses. The graph shows what has happened to new home prices in the Covid period. Note the 30% rise in nominal prices (20% real) ended in early 2022. Since then, nominal prices have been flat, but real prices have declined and reduced the 2020-2024 rise to only 5%.
Add in investor optimism and the homebuilder stock performance is likely overdone. Yes, the price/earnings ratios look reasonable, but that is a common characteristic of cyclical company stocks. At the top, they look cheap, and, at the bottom, they look expensive.
With PulteGroup leading off this earnings report season, their negative comments could be a forewarning of more reality adjustments ahead. Here is a summary from Yahoo Finance - "PulteGroup stock tumbles despite topping Q3 profit estimates."
"Homebuilder PulteGroup (PHM) beat third quarter profit estimates as lower mortgage rates brought more home buyers into the market, boosting demand for new home construction. However, the stock is under pressure after the company spoke about buyer incentives and a shakiness in the housing market moving forward."
Happy thoughts are boosting the stock market. The rationale is based on general issues like today's lower inflation, lower interest rates, and exciting AI outlooks. However, using such top-down logic overlooks details and counterpoints. So, do not assume the supposed beneficiaries (like homebuilders) are on straight, smooth roads to riches. Instead, expect investors' favorite stocks are likely overpriced. That makes them susceptible to declines when the road winds, buckles, and detours.