Before Buying Housing Stocks, Inspect the Market's Foundation for Cracks

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The homebuilding sector on Monday was upgraded by KeyBanc analyst Kenneth Zener. Names like D.R. Horton (DHI) , Lennar Corp. (LEN) , and PulteGroup (PHM) , all raised by KeyBanc to an overweight rating, jumped higher during Monday’s session.

The upgrade was based on valuation. According to KeyBanc, these stocks have performed so poorly that there is now more upside than downside. Year to date, DHI is down 33.2%, LEN lost 33.1%, and PHM slipped 29.6%.

The timing of this upgrade seems strange, coming just ahead of a slew of important housing data.

Later on Monday, the National Association of Home Builders released a survey, and the results weren’t pretty. The NAHB’s housing market index reached its lowest point in over two years. It marked the ninth consecutive monthly decline in home builder sentiment, which appears to be falling off a cliff.

Image via Fair Economy

More data is on the way. On Tuesday, monthly figures for housing starts and building permits will be released by the Census Bureau. On Wednesday, the National Association of Realtors’ monthly report on existing home sales will be released. Also on Wednesday, Lennar and K.B. Home (KBH)  are scheduled to report earnings.

Instead of charting these names individually, let’s look at the sector as a whole. The S&P Homebuilders SPDR (XHB)  exchange-traded fund is a bellwether for the industry, and its chart remains bearish.

Despite Monday’s optimism, XHB remains in a downtrend (diagonal lines). The ETF is also trading below its 50-day (blue) and 200-day (red) moving averages. Despite significant media coverage of KeyBanc’s optimism on the sector, Monday’s volume was just slightly above average (arrow).

Chart by TradeStation

Since this upgrade was based on valuation, consider this: All seven of the homebuilding stocks that were upgraded by KeyBanc  — Lennar, PulteGroup, D R Horton, KB Home, Meritage (MTH) , Toll Brothers (TOL) , and TopBuild Corp. (BLD)  — were priced lower in June. If valuation is a key concern, why should investors pay more for those stocks today?

The core of Zener’s thesis is that historically, the housing sector falls by an average of 41% during a downturn. XHB has already fallen by 32% since reaching its all-time high in December.

While that concept seems reasonable, keep in mind that the housing rally of 2020 and 2021 was anything but average. A massive, pandemic-driven shift to work-at-home, combined with rock-bottom interest rates, pushed demand forward.

This unique set of circumstances caused housing valuations to explode higher. Because of the size and nature of the real estate rally, I’m expecting a larger-than-average pullback in both housing prices and housing stocks.

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