What Recession? Homebuilders Hit New Highs as the Housing Market Remains Tight

The recession has done little to slow a red-hot housing market. In fact, it may have strengthened it. The S&P 500 Homebuilding index just hit a new all-time high this week – its first since 2005.

It’s unusual to see such strength in residential real estate during an economic downturn, but consider the following:

Mortgage rates just dropped to new lows. This year’s edition of quantitative easing from the Federal Reserve has pushed Treasury yields to near-zero, while term and default premiums have remained subdued. A prime borrower can now pay just over 3% for a 30-year home mortgage.

Millennials have notoriously postponed marriage and children until later in life compared to previous generations. But in recent years, household formation has picked up in the nation’s most populous demographic cohort. Growth in owner-occupier households outpaced that of renter households over the last few years and showed signs of acceleration in Q2.

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The coronavirus, and the work-from-home movement that accompanied it, has served to strengthen the demand environment. Homebuilders are wary of predicting a long-term behavioral changes, but some inhabitants of densely populated urban areas are interested in escaping crowds during the pandemic. Here’s Ryan Marshall, CEO of PulteGroup, Inc.:

As far as the markets that we highlighted where we are seeing an increase in our local business as a result of an urban exodus, if you will, I’ll use that term loosely, San Antonio, North Florida, Southwest Florida which for us would be the Naples, Fort Myers, Sarasota, kind of West Coast of Florida, and then we’re also seeing a bit of it in the Northeast corridor which is middle and Southern Jersey, and in to Pennsylvania. So there, I think we are seeing some folks that maybe were living closer to the city, New York City that is, looking for an opportunity to be a little bit more suburban in New Jersey and Pennsylvania.

Of similar mind was Bill Wheat, CFO of DR Horton, Inc. Here are his thoughts on the aforementioned urban exodus:

I think what you’re referring to is a longer-term trend I think is continuing. And I think certainly the pandemic’s had an effect on it. We would generally agree that that is a trend that probably is accelerating right now, but it’s still too early to know the depth of that and the sustainability of it.

And being forced to quarantine or work from home for extended periods has people longing for improved living areas. Michael Murray, COO of DR Horton, Inc, had this to say:

We are seeing more consideration given to a setting that accommodates a better work from home environment; whether it’s an extra bedroom to be used for a classroom, an office, a playroom that provides a little more space.

Simultaneously, the supply of existing homes remains low. Baby boomers are largely aging in place, staying in single-family housing at an age when prior generations might have downsized or moved to retirement communities. And given the havoc that COVID-19 has wreaked on senior housing, it’s hard to see a change in behavior anytime soon.

The supply of newly-built homes is similarly tight. The number of new housing starts just spent more than a decade below the 60 year average and is still far below the levels seen just before the Great Financial Crisis. A strong opening to 2020 pushed starts back above average for the first time since 2007, but progress stalled thanks to nationwide stay-at-home orders in the spring.  

With supply and demand clearly out of balance, you might expect an upward bias in home prices. And for existing home prices, that expectation would be right. But price trends for new homes are a little more nuanced.

The median price for new homes has actually fallen over the last two years, despite the supply-demand imbalance. Here’s Mr. Marshall to offer one explanation.

Go back to fall of 2016. We talked as a company that we felt that we had an opportunity to reposition our business to be a bit more balanced in the consumers that we target, and we laid out that ideally we wanted our first time buyer business to be about 35% of our businessSo what you’ve seen is it’s gone from our business being 26%, 27% first time to we’re now in the 31%, 32% and we’re moving much closer to that ideal target of 35%.

The recent surge in demand has overwhelmingly come from first-time home buyers, so homebuilders have largely shifted some focus away from building high-end, high priced homes, in favor of smaller, less-expensive ones, that accommodate their new customers.

So far it’s paid off for them.

Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.

A Risk Appetite Assessment

The S&P 500, Dow Jones Industrial Average, and Nasdaq are each within a few percent of their all-time highs, yet for the last 6 months, stocks have struggled to break through overhead resistance with any conviction. The Cumulative Advance/Decline Line indicates that breadth is at least adequate, and sentiment readings are far from stretched, but still, prices remain largely stagnant. One problem could be a lack of risk appetite. Strong equity uptrends are generally a reflection of increased risk-taking from investors, and ratio analysis is a great tool for gauging the appetite in the current environment.

The debate over Growth and Value has dominated the investment landscape for decades. Growth stocks certainly led the way higher during the dot com rally of the late 1990s, but then led on the downside as the bubble popped. The tendency of Growth to outperform during uptrends has been apparent in recent years as well.

Growth vs Value

The ratio of S&P 500 Growth to S&P 500 Value rallied from 2013-2015 as stocks broadly advanced, but then declined from late 2015-2016, a period where equity markets struggled to set new highs. Growth bottomed relative to Value at the end of 2016, and stocks soared in 2017. The ratio climbed all the way through the Dot Com high of 1.57, but then stalled at the 261.8% retracement from the 2015-2016 decline. The August decline confirmed a bearish RSI momentum divergence and got to its most oversold level since 2016.

In short, this multi-year trend of Growth outperformance is on life-support. The ratio needs to work off its momentum problems and recover the 2000 highs, or this false breakout could be just the start of Value’s strength.

Other flavors of domestic equities are showing a lack of risk appetite as well. Simply comparing the Consumer Discretionary sector to Consumer Staples yields similar results to those above. This ratio is great because it just makes sense: the numerator is the equivalent of buying a new car, and the denominator is buying toothpaste – people are only doing the first when times are good.Discretionary vs Staples.PNG

Like Growth/Value, Discretionary/Staples made it all the way back to 2000 highs in 2018. But the ratio put in a bearish momentum divergence in the third quarter of that year and has struggled ever since. Momentum is stuck in a bearish range, and the current ratio is below its 200D moving average. While clearly not in an uptrend, we’ll have to see a break of last year’s lows to get more negative on this relationship.

Small cap stocks relative to large caps have moved sideways for much of the last 5 years. A strong 2016 was followed by weakness in 2017, but the period since mid-2018 has been especially weak. Small vs Large

Momentum, too, has been decidedly negative since March, and not even a sharp September rally could break the ratio’s downtrend. Support from the 2007-2009 lows, just above 0.50, is a logical place to try and find a bottom, but for now the trend is down.

Looking abroad, the ratio of Emerging to Domestic markets is another great measure of risk-appetite, and it’s sending a similar message. The false breakdown in early 2016 was a near-perfect indicator of the bottom in U.S. equities, and four years later we’re back to the same key level. The 2019 downtrend is very much intact, and momentum has been stuck in a bearish range for most of the year. Technicians argue that the more times a level is tested, the more likely it is to break. This is the fifth (sixth?) attempt to get through 0.70 – a breakdown here would be point towards further risk aversion by investors.

Emerging vs Domestic

On the other hand, momentum diverged positively at both the July and August lows, and has yet to get oversold during the September decline. We’ll want to see a bounce and break of the most recent swing high to confirm the divergence, but a bounce off of multi-year support might make some sense.

Risk aversion hasn’t been limited to equities either. The bond market is significantly larger, and investors have favored Investment Grade Corporate Bonds over their riskier counterparts since the fall of 2018.

High Yield vs Corporate

High Yield bonds took the brunt of the 2015-2016 decline in stocks, but then ripped higher over the next three years. When stocks began to fall again in October of last year, High Yield began to to underperform, too. In August, the ratio fell below the 2014 swing high – a sign of more bad things to come. But buyers came to the rescue and pushed the group back above the key support level. Momentum even managed to get overbought on the recent rally, but the ratio has more work to do. It’s still below a downward sloping 200D moving average and the downtrend line from the highs. The false breakdown might have been the key turning point, but we’ll need to see more bullish evidence before calling this a broken downtrend.

For stocks to move higher, we’ll probably need to see more appetite for risk in the markets. The safety trades have clearly been in control, but several of the relationships above could be at bullish turning points. More concerning would be a loss of leadership from Growth stocks, which had managed to lead even as the other ratios faltered. However things resolve, the next few weeks should be fun to watch.

Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.