Homebuilder Stocks Face Threats as Bond Yields Rise

The major homebuilding stocks continue to face headwinds as many investors remain wary as the companies continue to produce large declines in shareholder value amid rising yields.

Shares of homebuilder companies have dipped the past two weeks. The 10-year Treasury note, an economic benchmark, has risen to nearly 3.4 percent, which is the highest level since 2011, and will impact both the retirement portfolios and the savings of consumers. Potential homeowners will face more hurdles as borrowing costs will continue to rise, making it more expensive when they obtain mortgages and home equity lines of credit.

These challenges could further impact the stocks of homebuilders as rising inventory numbers, lower home sales and volatility in these stocks have dampened enthusiasm among investors. August reported new home sales of 629,000, which is 2 percent below the year-to-date average of 639,000, which demonstrates a “slowing growth rate consistent with slowing existing home sales and rising inventory,” wrote Kenneth Zener, an equity research analyst for KeyBanc Capital Markets, in a Sept. 26 research note.

[See: 7 Things Warren Buffett Says About the Stock Market.]

Zener, which has a negative outlook, states that caution is warranted in the sector because “acceleration is not in the cards, in our view. When the Federal Reserve increased interest rates in the past, housing activity succumbed to the pressure and declined.

“With the Fed tightening cycle impacting the 10-year rate, after 2017 hikes had no effect, we think exposure to rate sensitive stocks is becoming more risky,” he wrote in an April 29 research report. “We now highlight that six of six Fed cycles always ended in down housing activity and declining sector returns.”

During these down cycles, homebuilding stocks declined by 35 percent and building products were half of that amount.

As the Fed continues its plan to hike rates through 2019, the sentiment from investors “towards both sectors remains highly challenged,” wrote J.P. Morgan analysts recently.

Homebuilding stocks suffer a two-fold effect in a period of rising interest rates, says Robert Johnson, a finance professor at the Heider College of Business at Creighton University in Omaha, Nebraska. The upward trend in interest rates means that the values of all equities are impacted because expected future cash flows are discounted at higher rates.

Some investors now view that bonds become relatively more attractive versus stocks, he says.

“The S&P 500 index currently sells at a trailing 12-month price-to-earnings ratio of 23.5 times, compared to a historical mean of 15.2,” Johnson says. “The 10-year is … essentially selling at a P/E ratio of 31 times earnings. When the implied yield on government bonds gets closer to the P/E ratio on stocks, many investors take a ‘risk off’ stance, rotating from stocks to bonds.”

Demand for purchasing new homes dips as mortgage interest rates rise, Johnson says.

Potential homeowners usually focus more on their monthly mortgage payments instead of the home prices and when interest rates rise, their payments increase.

“People suffer regret aversion, a behavioral finance principle that leads people to make poor decisions,” he says. “As rates rise, potential homebuyers regret that they didn’t make the home buying decision sooner when rates were lower. Many decide to forego buying a new home, waiting for rates to pull back. This is particularly salient in the current market as rates have recently spiked after slowly increasing over the past few years.”

[Read: 3 Ways to Build an ESG Bond Portfolio.]

Los Angeles builder KB Home (ticker: KBH) continues to meet challenges and at about $21 a share this week after reaching a high of $36.98 on Jan. 12. The builder’s stock dipped by as much as 6 percent intraday last week — the most in six months, even though KB Home reported better-than-expected third-quarter results, says Jack Willoughby, a writer-in-residence for S3 Partners, a New York-based financial analytics company, in an Oct. 3 research report. The stock has fallen by 36 percent compared to January when KB Home reached $38.50.

The volume of shares shorting KB Home has been declining — from 13 million shares on Dec. 5 to 5.7 million shares on Sept. 25, a dip of 50 percent, according to S3Partners statistics.

“Shorts have been quick to vacate their positions, even though their moves anticipated a broad, steady decline in KBH’s share price,” Willoughby says. “The record tells a story of waning conviction. Early signs of excessive enthusiasm appear already in the reported statistics for new U.S. home sales.”

The company’s management team “fueled investor nervousness” during their third-quarter conference call when they lowered annual 2018 revenue estimates to $4.6 billion, which was the low end of previous expectations, he wrote. KB Home’s executives said they had been too aggressive in their timing on the opening of new communities.

The company’s stock is rated “sector weight” by KeyBanc Capital Markets because the company reported favorable third-quarter earnings-per-share results, which is higher than its peers and 2019 revenue guidance.

D.R. Horton ( DHI) reported in July positive third-quarter results that beat estimates because sales orders and home closings were higher by double digits, the company’s executives said.

In a July 27 research report, KeyBanc Capital Markets rated D.R. Horton, the Arlington, Texas, home builder as overweight with a price target of $54 a share. The company’s shares traded this week near $38, after being nearly $53 per share in January.

The company still face potential issues if the estimates for job or income growth fall lower, if higher interest rates undermine home prices and if mortgage-lending standards are tightened, he added.

[See: 7 of the Best ETFs to Buy for Long-Term Investors.]

Other homebuilding stocks have seen their share prices drop drastically even as they reported positive earnings in the last quarter such as Lennar ( LEN) and Hovnanian Enterprises ( HOV) PulteGroup ( PHM) reported good second-quarter results with a revenue increase of 25 percent, and has a rating of sector weight despite rising gross margins from KeyBanc Capital Markets, Zener wrote. The company traded this week ad less than $24 after a 52-week high of $35.21.

Beazer Homes USA ( BZH), which designs and builds family homes for first-time, move-up, or retirement-oriented home buyers, fell to $9.79 a share, a dip of more than 50 percent from its 52-week high.

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Homebuilder Stocks Face Threats as Bond Yields Rise originally appeared on usnews.com