Homebuilding Stocks – Buy on Dip?

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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

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.

Homeownership Rate

Homeownership Rate

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

Housing Remains More Affordable than Previous Cycles

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

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

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.

Bottom Line

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.

The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are as of the date of this report, are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in this material will be realized.

About Risk

All investments are subject to market risk, including possible loss of principal. Stocks and bonds can decline due to adverse issuer, market, regulatory, or economic developments. Bonds are also subject to credit risk, in which the bond issuer may fail to pay interest and principal in a timely manner, or that negative perception of the issuer’s ability to make such payments may cause the price of that bond to decline. A bond’s prices are inversely affected by interest rates. The price will go up when interest rates fall and go down as interest rates rise.

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.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302.

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Amit Soni, CFA

Director and Portfolio Manager, New York Life Investment Management

Amit Soni is a Director and Portfolio Manager in the Strategic Asset Allocation & Solutions (SAS) team at New York Life Investment Management. He focuses on quantitative and macro-economic investment research and portfolio management for the asset allocation

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