Housing Stocks Are Pricing In A Big Downturn

Our theme of Housing Stocks, which includes the stocks of home builders, building products companies, and home improvement players, has declined by about 42% year-to-date in 2022, considerably underperforming the S&P 500, which remains down by about 22% over the same period. The housing market appears to be at a crossroads of sorts. Demand for housing has remained quite solid so far, given the strong labor market, rising wages, and demand for larger homes following the Covid-19 pandemic. Per data from Realtor.com, the national median listing price for active listings for May was $447,000, up 17.6% compared to last year, with homes also spending less time on the market versus last year. However, on the other hand, mortgage rates have soared, with rates on 30-year fixed mortgages rising from an average of 3.1% in December 2021 to about 5.8% currently, making financing homes more expensive. Construction material costs have also remained high, amid strong demand and supply chain issues, putting pressure on home builders’ margins.

Now, the markets don’t seem too optimistic that the demand momentum will last, leading to a big sell-off in housing stocks this year. With inflation surging, the Federal Reserve has turned increasingly hawkish. Last week the U.S. central bank raised rates by 0.75%, its largest hike since 1994, and more similar rate hikes are looking likely. It could get still more expensive for people to purchase homes, as mortgage rates rise further, potentially denting demand. The Fed’s tightening is very likely to push the U.S. economy into a recession in the coming quarters, and a downturn will almost certainly put pressure on the housing market. That said, any potential decline in housing is unlikely to be as severe as the 2008 crisis. Housing prices are currently overheated due to a mismatch between supply and end-user demand and low-interest rates, unlike the 2008 crisis which was driven by high levels of leverage and speculation. Leverage in the housing market is also currently well below historical levels, with total mortgage debt in the U.S. standing at under 43% of current home values.

With the housing stock theme down by over 40% this year, it’s looking like much of the coming pain is being priced in. That being said, it’s hard to time an entry into the sector, as a weak economy could mean that pressure on stocks will remain. Within our theme, Floor and Decor Holdings has been the weakest performer, with its stock declining by about 50% year-to-date. On the other side, Home Depot has fared a bit better than the other names in the theme, with its stock falling by about 33% year-to-date.

Stock prices have fallen precipitously across sectors over recent months and we are now in a bear market for the first time since March 2020, when the Covid-19 outbreak triggered a market crash. We capture key trends in the Dow during and after major market crashes in our interactive dashboard analysis, ‘Market Crashes Compared.’

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