Up 63% This Year, Despite Higher Rates, Will The Homebuilding Theme Continue To Outperform?

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Our theme of Housing Stocks, which includes the stocks of home improvement players, building supply companies, and home builders such as Pulte Group (NYSE:PHM) and Lennar (NYSE:LEN) has fared well in 2023, rising by a solid 63% this year so far. This compares to the S&P 500 which remains up by about 21% over the same period. Mortgage rates in the U.S. have soared due to the Fed’s hawkish stance and the post-pandemic surge in inflation. The average interest rate for a 30-year, fixed loan stood at over 7% as of last week, compared to levels of under 3% in 2021. This is making home financing much more expensive compared to the pre-pandemic era.

However, this is actually benefiting builders of new homes. The increased rates make it more likely for existing homeowners, who have locked-in mortgages at lower rates, to stay in their homes, reducing the incentive to sell. This has led to a decrease in the market for both upsizing and downsizing homes due to the lock-in effect. This has resulted in a shortage of existing homes for sale. In October, existing home sales dipped by 4.1%, reaching a 13-year low, according to the National Association of Realtors. This trend has proven advantageous for new home builders, as the overall housing market still faces a significant under-supply. October sales of new single-family homes reached a seasonally adjusted annual rate of 679,000, marking a 17.7% increase from October 2022. Moreover, median sales prices for new homes have declined to $409,300., down from $496,800 in the same period last year. This lower pricing could also be stimulating demand. However, new homebuilding activity saw a bit of a slowdown with single-family housing starts increasing by 0.2% in October, compared to a rise of about 3.2% in the year-ago period.

Now LEN stock has seen extremely strong gains of 85% from levels of $75 in early January 2021 to around $140 now, vs. an increase of about 25% for the S&P 500 over this roughly 3-year period. However, the increase in LEN stock has been far from consistent. Returns for the stock were 52% in 2021, -22% in 2022, and 55% in 2023 (YTD). In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 21% in 2023 (YTD) – indicating that LEN underperformed the S&P in 2022. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Consumer Discretionary sector including AMZN, TSLA, and HD, and even for the megacap stars GOOG, MSFT, and AAPL.

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In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could LEN face a similar situation as it did in 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?

Although it is difficult to gauge the near-term outlook for the theme, there remains a fundamental under-supply of homes, with a wide range of estimates projecting that the U.S. may be short of anywhere between 1.5 million to 5 million homes. [1] This might indicate that housing players may still have good demand visibility, with volumes and revenues likely to hold up. This could help companies such as PulteGroup and Lennar. There is also some optimism in the market that the Federal Reserve could pause its interest rate hikes as inflation cools. The consumer price index, (CPI) a closely watched inflation gauge, rose 0.1% in November and was up by just 3.1% versus last year. This could eventually help to ease mortgage rates and drive housing demand further.
 Returns Dec 2023
MTD [1]
YTD [1]
Total [2]
 LEN Return 10% 55% 233%
 S&P 500 Return 2% 21% 107%
 Trefis Reinforced Value Portfolio 2% 30% 569%

[1] Month-to-date and year-to-date as of 12/13/2023
[2] Cumulative total returns since the end of 2016

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  1. Washington Post []