Housing stocks, which have rebounded this year with the market, are still far off their one-year highs and could continue to plunge even further as the fundamentals of the U.S. housing industry weaken, according to various market watchers. Companies such as Lennar (LEN), D.R. Horton (DHI), KB Home (KBH), PulteHome (PHM), Toll Brothers (TOL) and Beazer Homes (BZH) could suffer the worst.

While the rising cost of homes, at record-highs, priced many buyers out of desirable markets, inventory levels were at their lowest levels in three years, leading to a decline in home sales. As inventory levels climb back, a myriad of concerns including ballooning mortgage rates, a decline in purchases by foreign buyers, and a new tax bill passed in late 2017, which capped the deduction for state and local taxes at $10,000, could further drag on housing stocks, per The Wall Street Journal.

“Suddenly the light turned off in the second half of the year, with sales tumbling down and inventory rising,” said Lawrence Yun, chief economist at the National Association of Realtors.

Housing Stocks Are Down Sharply Despite January Bounce 

  • KB Home; 2-month stock performance: -41.8%
  • Beazer Homes; -40.8%
  • Lennar; 1-34.3%
  • Toll Brothers; -29.8%
  • D.R. Horton; -24.4%
  • PulteHome; -17.5%

Cooling Housing Market

In 2018, fundamentals in the housing sector were already weakening despite a strengthening economy and unemployment at a 50-year low. This week, after starting the new year off strong, home builder stocks fell on weaker-than-expected orders from KB Home. The SPDR Homebuilders ETF (XHB) is up 8.2% YTD through Monday, still outperforming the S&P 500’s 3% return.

The absence of a correlation between the once red-hot sector and the broader economy defied predictions that healthy growth would revive the struggling sector. Now, more negative macro industry forces could affect the earnings and stock performance of many housing industry leaders, already facing a tougher crowd as the market combats fears of trade tensions, rising rates and a series of recent market downdrafts. 

“In 2019, the economy will most likely grow, but a cooler housing market will contribute less to the overall economy,” wrote real estate broker Redfin in a December report.

Robert Dietz, chief economist at the National Association of Home Builders, is forecasting single-family housing starts to grow by less than 2%, compared to 4% in 2018 and 8% in 2017. He suggests that the housing market’s woes are “telling a story that the economy is slowing down.” Housing, which comprises roughly 15% to 18% of GDP, helps drive other sectors of the economy – boosting consumer confidence, home-improvement spending, construction and mortgage lending. Therefore, its weakness is viewed by some as signaling a larger plunge.

Soft Landing for Housing Market

Not all are so bearish. Economist Yun expects strong underlying demand, driven by millennials whose ability to buy has risen with slightly lower prices, should keep the market about flat in 2019. Meanwhile, with home price growth slowing, high inventory levels and stabilized mortgage rates could give the sector a breather as buyers rush to get in before rates increase again.

Others, including Ralph McLaughlin, deputy chief economist at CoreLogic Inc., see a “soft landing” for the housing market as the most probable and best-case scenario. He warned, however, that “markets often follow animal spirits or psychology,” capable of turning soft landings into crashes if buyers and sellers start to panic.

Much will rely on the Fed’s actions to up interest rates, which economists now expect to end 2019 at 5.5%. If rates continue to rise, eating into mortgage demand, the housing market will likely fall further unless wage growth jumps significantly. On the upside, the Mortgages Bankers Association reported U.S. mortgage applications up 23.5% for the week ended Jan. 4 versus the previous week, per Barron’s.

“Unless interest rates begin to fall in the near-term, we think downside risks remain for the housing market and with it for the home-builder stocks,” wrote Deutsche Bank in a note in which the firm downgraded shares of PulteGroup and Toll Brothers to hold, while upgrading Lennar to buy based on valuation, per Barron’s

Looking Ahead

It’s important to note that these housing stocks typically experience massive declines during economic cycles, making a strong comeback in bull markets. For example, shares of Lennar have risen more than six-fold since the stock’s bottom during the 2008 financial crisis. Thus, the savviest investors looking at the housing sector would commit to a long-term investment horizon, and buckle up for a wild ride.