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  1. Home
  2. / Investing
  3. / Stocks

Are Homebuilders in for a Hurting as Confidence Wanes?

The most recent indication of a potential change in bullish sentiment is the marked decline in the sales expectations.
By KEVIN CURRAN Mar 17, 2022 | 03:16 PM EDT
Stocks quotes in this article: LEN, TOL, KBH, XHB, FMCC

Markets at present are plagued by uncertainty stemming not only from the ongoing Russian invasion of Ukraine, but supply-chain issues bubbling over as China locks down and inflation that continues to defy the formerly popular phrasing of "transitory."

Amidst the backdrop, home prices have been a bulwark against the storm, remaining incredibly steady. In fact, per St. Louis Fed data, housing prices have seen their largest jump since the global outbreak of the Covid pandemic, accelerating most strongly as markets entered significant turmoil.

Among the largest beneficiaries of this trend were homebuilders such as Lennar (LEN) , Toll Brothers (TOL) , and KB Home (KBH) , all of which helped Americans social distance and work from new homes.

As an indication of this strength stemming from the pandemic, the SPDR S&P Homebuilders ETF (XHB) easily outpaced the overall S&P 500 in its recovery from the market's March 2020 nadir. Needless to say, confidence has ridden high in the space for quite some time.

However, as mortgage rates move higher, this confidence appears to be wavering.

Turning Tide?

The most recent indication of a potential change in bullish sentiment is the marked decline in the sales expectations cited by the National Association of Home Builders/Wells Fargo Housing Market Index.

The index, which bills itself as tracking the pulse of the single-family housing market, indicates that sales expectations for the next six months declined a steep 10 points from February. While the index remains buoyant at 70, indicating generally still-positive sentiment, the sharp decline is certainly out of the norm.

The rationale for this rapid pullback in confidence is multifaceted.

"Homebuilders face many headwinds; inflation, labor shortages, and supply-chain issues have increased the cost of construction projects," Abbey Omodunbi, Senior Economist at PNC Financial Services told Real Money. "Also, increased economic uncertainties continue to weigh on homebuilder sentiment."

Echoing this sentiment, Robert Frick, Corporate Economist at Navy Federal Credit Union, noted that the chief concern for homebuilders at present is found in supply-chain shortages.

"Builders' big worry is still the lack of supplies, from windows to fixtures to appliances," he noted. "That will put a brake on new home construction."

Adding to these issues is a notable rise in mortgage rates as Fed tightening also impacts the industry. According to Freddie Mac (FMCC) , the 30-year fixed-rate mortgage exceeded 4% for the first time since May 2019.

"The Federal Reserve raising short-term rates and signaling further increases means mortgage rates should continue to rise over the course of the year," the government-sponsored enterprise said in a press release on Thursday. "While home purchase demand has moderated, it remains competitive due to low existing inventory, suggesting high house price pressures will continue during the spring homebuying season."

Of course, these expected price increases and higher rates are going to have an impact on demand.

No Cause for Panic

Yet, all of these factors bearing down on the sector are not enough to shake the confidence of analysts and economists.

"Overall, PNC expects the housing sector to remain strong this year," PNC's Omodunbi explained. "Demand will remain solid and new construction should improve moderately in the second half of the year as supply chains normalize."

While accounting for the understandable catalysts for waning confidence noted in sentiment surveys, LendingTree Senior Economic Analyst Jacob Channel was likewise optimistic.

"Demand for new housing isn't going to disappear -- even if it probably won't be as extreme as it was over the last two years -- and there's no reason to assume that there will be a major crash in the housing market," he told Real Money. "As a result, while some builders may benefit from pivoting into a new line of work, there are still plenty of opportunities for those who want to stay the course and continue to fight through supply shortages and rising rates. This is especially true given that the summer home buying season is going to kick off soon, which will mean that many people will be in the market for a newly built home."

There were also some points to pacify investors on mortgage rate trends from industry economists.

"Mortgage rates, while now at least a percentage point higher than a few months ago, are still relatively low historically speaking and shouldn't affect sales of new or existing homes much," Navy Federal Credit Union's Frick opined. "The Fed increasing the federal funds rate will only have a weak effect on mortgage rates, which are pegged to the 10-year Treasury yield and that rises and falls on the economy's prospects much more than any Fed action. So the Fed slowing federal fund hikes will affect mortgage rates little."

As such, Frick chided those expecting some pain in the sector as overly pessimistic. Citing the 2020 Covid-driven crash as an anticipated spark of a housing crisis, he eschewed suggestions of any looming difficulty in the sector.

"As long as housing supply remains low, and right now there is no end in sight for that, homebuyers should snap up all the homes builders can build," he concluded. "The constraint for this year, at least, will remain a lack of supplies."

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At the time of publication, Curran was long LEN.

TAGS: Mortgages | Economic Data | Economy | Federal Reserve | Interest Rates | Investing | Stocks | Construction & Engineering | U.S. Equity

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