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  1. Home
  2. / Investing
  3. / Stocks

A Cooling Housing Market Should Present Opportunity for Those Who Are Patient

It could be tough sledding for housing activity in coming quarters due to higher interest rates, so it's best to wait for lower entry points in homebuilder stocks.
By BRET JENSEN
Aug 22, 2022 | 11:00 AM EDT
Stocks quotes in this article: LGIH, TOL, BZH, JOE

The quick move back up in interest rates definitely is impacting the housing sector in 2022. Refinancing activity has completely dried up and mortgage companies lay off folks by the thousands. Higher mortgage rates have also led to slower housing sales as well as a rise in cancellation rates for new builds.

Back in the second quarter I added significantly to the allocation of housing-related plays in my portfolio using covered call orders. Among the names I opened a position in or added to an existing position were LGI Homes (LGIH) , Toll Brothers (TOL) , Beazer Homes (BZH) and The St. Joe Company (JOE) .

With some homebuilders selling at three to four times earnings then, I reasoned they would hold up well even if profit estimates continued to come down as the bad news was likely priced into their stocks. In addition, the homebuilders had large order backlogs to still work off and would benefit from falling prices for building supplies such as lumber. That bet has paid off across the board up to this point as all of those covered call positions are currently in the money and look set to expire profitably in coming months as their options run out. That said, I have backed off the sector in the third quarter because it could be rough sledding for home activity over the next few quarters.

Higher mortgage rates are starting to trigger drops in asking prices even as inventory levels remain low. Apartment rents also seem to be stabilizing after rising more than 15% on average in 2021. Unfortunately, these trends will take time to show up in the shelter component in the monthly Consumer Price Index (CPI) reports. Considering that the housing component has by far the larger weighting in the survey, it means headline inflation will remain high until smaller price increases for shelter slowly are reflected in the report.

I believe the housing market is likely to be at a Mexican standoff for a few quarters. Sellers are reluctant to drop prices sufficiently to snare a sale while buyers are still navigating through the lowest housing affordability in decades and hope mortgage rates will drop in the quarters ahead. My view is that the Fed will continue to hike rates until the country is in a real recession. There will be no soft landing. I expect the central bank to pivot at some point in the first half of 2023.

If we do get a hard landing as I expect, I will have plenty of dry powder to put back into the market at lower entry points given my current cash allocation. In addition, I hope to acquire some raw land in a desirable area of Greenville, South Carolina, at a discounted price in that scenario. When the Fed reverses course, it will be time to take out a construction loan to build a place there when building supply prices are still in the dumper and home builders are desperate for work. At least that is the plan. By the time the house is finished, the economy should be rebounding. We will see how that plan works out.

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At the time of publication, Jensen was long BZH, JOE, LGIH and TOL.

TAGS: Economy | Federal Reserve | Interest Rates | Investing | Stocks | Housing Market | Construction & Engineering | Real Money

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