Homebuilding stocks and ETFs, on track for their best year since 2012 amid Federal Reserve rate cuts, have been racing past even a soaring S&P 500 -- outperformance that's taking place amid a long list of warning signs that threaten the sector's long-term growth.
The SPDR S&P Homebuilders exchange-traded fund (XHB), which also includes companies that supply building-products and home-furnishing, has outperformed the broader market, rising 34% this year versus the S&P 500’s 19.5% return. D.R. Horton Inc. (DHI) and Beazer Homes USA Inc. (BZH) have gained well over 40%, while LGI Homes (LGIH) is up near 80% and KB Home (KBH) has advanced 63% in 2019. This trend was outlined by a Wall Street Journal report.
The momentum has been driven largely by lower mortgage borrowing costs accelerated by Fed rates cuts, marking a sharp reversal from last year's stagnant housing market.
The Fed further bolstered the rate-sensitive industry on Wednesday, at least for the short term, by announcing more rate cuts. But the mixed trading of housing stocks on the announcement, with many marginally down, indicated that investors in the sector remain cautious.
Significance For Investors
The big question is how long this outperformance can last given a number of forces that could thwart the sector's growth. While sales of previously owned U.S. homes were up in July, another key indicator is showing major weakness. Housing starts, a measurement of new home construction, have been down for three straight months.
Meanwhile, wealthy home buyers are pulling back in some of the most expensive markets, as outlined by Bloomberg. Toll Brothers Inc. (TOL), the largest publicly traded luxury home builder in the U.S., said that orders in California fell 36% from a year ago. That's a sign that upscale buyers are “paying more attention to the stock market” and becoming more cautious, according to Bloomberg analyst Drew Reading.
The biggest driver of housing stock gains, the Fed, also could prove to be a stumbling block. These stocks' revival was largely driven by the Fed’s decision in July to cut interest rates. But the Fed recently signaled that it may lower rates at a more gradual pace to hold back the recent plunge in mortgage rates, per the Journal. The Fed effectively did that on Wednesday by lowering rates only a quarter of a point. Meanwhile, the broader US-China trade conflict threatens to slow the economy at large, and therefore eat into housing growth.
“Solid household formations and attractive mortgage rates are contributing to a positive builder outlook,” said Robert Dietz, the chief economist at the National Association of Home Builders, per the Journal. “However, builders are expressing growing concerns regarding uncertainty stemming from the trade dispute with China.”
That concern highlights the fragile nature of the homebuilding stock recovery. Investors already experienced a massive downdraft in the sector in 2018, when SPDR S&P Homebuilders ETF, for example, plunged more than 30% between January and December. If the global and U.S. economy slows too fast or if trade tensions escalate too high, even low mortgage rates may not be able to offset the damage.