Homebuilding Stocks – Buy on Dip?
Investors entered 2018 on an optimistic note, backed by a solid macro-economic environment. However, a faster-than-expected rise in Treasury yields and inflation expectations caught markets off guard. On Monday, February 5, we saw the largest percentage decline in S&P 500 Index since August 2011.
We believe that this sell-off is creating opportunities in certain sectors, homebuilding being one of them. The S&P 500 Homebuilding Sub Industry Index is down 16.75% from its highs in mid-January. We see the recent price action in the sector as an overreaction, and consider the current levels to be an attractive entry point for both a tactical and a long-term strategic position.
The S&P 500 Homebuilding Index Down Significantly
Source: Bloomberg, as of 2/5/18. An investment cannot be made in an index. Past performance is not indicative of future results.
The fundamentals for the sector are among the strongest we have seen in some time. In 2017, we observed a meaningful pickup in homeownership (Figure 2), a trend we expect to continue, as millennials finally transition from renting to owning.
Source: Bloomberg, as of 2/5/18. An investment cannot be made in an index. Past performance is not indicative of future results. U.S. Census Bureau homeownership rate tracks the percentage of households who own their homes.
Housing Remains More Affordable than Previous Cycles
Home Affordability Composite Index
Source: Bloomberg, as of 2/5/18. An investment cannot be made in an index. Past performance is not indicative of future results. National Association of Realtors tracks the affordability of housing, using a mix of median incomes, median home prices, and mortgage rates.
The National Association of Home Builders (NAHB) market sentiment indicator sits close to highs not seen since the late 1990s.
National Association of Home Builders’ Market Index SA
Source: Bloomberg, as of 2/5/18. An investment cannot be made in an index. Past performance is not indicative of future results. National Association of Home Builders Market Index SA is a monthly survey of NAHB members designed to take the pulse of the single-family housing market. The survey asks respondents to rate market conditions for the sale of new homes now and in the next six months, as well as the traffic of prospective buyers of new homes.
Moreover, despite a run-up of 73% by homebuilding stocks in 2017, the strong earnings momentum has kept the valuations within very reasonable levels. The sector currently trades at a trailing price-to-earnings (P/E) ratio of 14.31, and has a forward P/E of only 11.01.
S&P 500 Index Homebuilding Index: Price-to-Earnings Ratio
Source: Bloomberg, as of 2/5/18. An investment cannot be made in an index. Past performance is not indicative of future results. Trailing price-to-earnings (P/E) is calculated by taking the current stock price and dividing it by the trailing earnings per share (EPS) for the past 12 months. This measure differs from forward P/E, which uses earnings estimates for the next four quarters.
The rise in Treasury yields may pose a headwind for the sector, but we believe the tailwinds emanating from a strong economy, healthy housing affordability, favorable trends in homeownership, and attractive valuations present a strong case for the homebuilding sector.
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S&P 500 Homebuilding Sub Industry Index – S&P Select Industry Indices are designed to measure the performance of narrow GICS® sub-industries. The index comprises stocks in the S&P Total Market Index that are classified in the GICS homebuilding sub-industry.
Home Affordability Composite Index measures the degree to which a typical family can afford the monthly mortgage payments on a typical home.
The NAHB/Wells Fargo Housing Market Index is based on a monthly survey of members belonging to the National Association of Home Builders (NAHB) that is designed to measure sentiment for the U.S. single-family housing market.
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