Lower Than Expected Housing Starts and Building Permits Could Be Problems for Homebuilders

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Investors have another group of earnings to consider on Tuesday. This week a slew of companies are slated to report earnings including 77 of the 500 stocks that make up the S&P 500. Investors will be looking for signs of supply chain relief and bottlenecks.

So far, a trend among consumer staple goods appears to be developing as a positive theme, which means these important goods are at least getting to market. Johnson & Johnson JNJ beat analysts’ earnings estimates despite missing revenues. The company reported success in its consumer goods divisions to push earnings higher. Proctor & Gamble Co PG and Philip Morris International PM also reported strong earnings by beating analysts’ estimates on the top and bottom lines. Additionally, Goldman Sachs analysts upgraded Walmart WMT to its Conviction Buy List.

On the negative side, starting in transportation, railroad Kansas City Southern KSU fell short on earnings estimates despite beating on revenue. The company cited lower carload volumes due to auto plant shutdowns, service interruptions, and increased regulation. Staffing company, ManpowerGroup Inc MAN beat on earnings but whiffed on revenue despite strong demand for skilled talent and labor. Complications with COVID-19 were cited as a contributing factor to the company’s lower revenues.

Despite these reports, a lot of talk is around Netflix's NFLX earnings that are scheduled for after the close.

On Sunday, China revealed that it experienced slower-than-expected economic growth in the third quarter. The country’s gross domestic product (GDP) grew at 4.9% compared to the second quarter of 7.9%. Growth was stymied by supply chain problems, energy shortages, issues with real estate developer Evergrande, and uncertainty around increased regulations and government crackdowns. Nomura analysts cut its fourth-quarter estimates for China from 4.4% to 3%, while ING Bank cut its projection from 4.5% to 4.3%. On the positive side, Chinese exports remain strong, and the National Bureau of Statistics reported that Chinese retail sales rose 4.4% in September.  

U.S. Housing Still Growing

Home sales are still rising in the U.S. despite the Census Bureau reporting lower than expected building permits and housing starts in September. In previous reports, homebuilders were focusing on the more profitable multifamily and luxury homes. However, the new report saw a swing back to single-family homes. On Monday, the NAHB Housing Market Index (HMI) revealed that homebuilders remain confident despite supply chain disruptions. While confidence has waned a little from earlier in the year, the HMI is still reading above historical highs stretching back to 1985.

Despite positive feelings from homebuilders, the preliminary Michigan Consumer Sentiment Index for September was released on Friday and revealed that consumers are far less hopeful. Those surveyed cited higher prices and supply chain issues as reasons for their gloomier outlook. This echoes the Fannie Mae Home Purchase Sentiment Index® (HPSI) from October 7. It found consumers are much more likely to see today’s home prices favoring sellers over buyers. Consumers are hopeful that prices will soften in the future as supply chains get back to normal.

SPX Inverse Head and Shoulders

CHART OF THE DAY: ASSOCIATION & CAUSATION. The S&P Homebuilders Select Industry Index ($SPSIHO—candlesticks) has moved mostly in sync with the 10-year Treasury Yield (TNX—pink). Data source: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platformFor illustrative purposes only. Past performance does not guarantee future results.

Building a Market: Homebuilders appear to be immune to rising interest rates. The S&P Homebuilders Select Industry Index ($SPSIHO) has been rising with the 10-year Treasury Yield (TNX) and is back above 1.6% this morning. The 10-year yield is correlated to mortgage rates, so many investors follow the TNX to keep a tab on mortgage rates. However, rising mortgage rates don’t appear to be stopping people from building new homes. So, why are the two indices closely linked?

There are a couple of reasons. First, coming out of the COVID-19 recession, both indices are benefiting from increased demand. There appears to be increased demand for homes or at least a restricted supply that can’t keep up with demand. And there’s increased demand for borrowing money. So, demand for homes means demand for borrowing money.

Second, yields are still historically low. Even though yields have been climbing, they’ve moved from 0.76% to 1.58% in the last year. That’s a nominal increase of 0.82. That’s not even a complete percentage point. So, while the cost may be higher over the life of the loan, it doesn’t appear to be enough to deter homebuying.

Finally, it’s not just regular working people buying homes; many homebuyers are actually professional investors and speculators. In August 2021, The Wall Street Journal reported that private equity firms like BlackRock, Inc. BLK were buying up residential properties by the neighborhood and even well-above market prices. Additionally, REITs like Invitation Homes Inc INVH and American Homes 4 Rent AMH are in the homebuying space. Real estate platform firms like Zillow ZG and Opendoor Technologies Inc OPEN are in the house-flipping business too. And then you must account for the many individual real estate investors out there who inspire the various house-flipping shows on home and garden channels.

This means it’s difficult to know how much of the housing market demand is from “real homebuyers” and how much is from investors. It’s also difficult to find a similar time in history for comparison to determine if the current investing and building trends are sustainable.

Leaving a Door Open: Speaking of Opendoor, the stock rallied more than 3% on bad news from competitor Zillow. Zillow announced it will temporarily halt its automated house-flipping operations. According to The Wall Street Journal, the company appears to have overspent on homes that are now requiring more work before they can be sold. Worker shortages are making things more difficult for the housing tech company. However, Opendoor has bought nearly twice the number of homes as Zillow and hasn’t reported any issues. Zillow traded more than 9% lower on Monday.

Opendoor isn’t the only competitor that is honing in on Zillow’s market share. Offerpad Solutions Inc OPAD operates a mobile real estate platform that allows consumers to seamlessly buy and sell homes from their phone or tablet. Offerpad hasn’t reported any issues in helping homebuyers get the workers they need either. Perhaps Zillow’s management has fallen short in building its partnerships.  

Timber!: A year ago, random length lumber (/LB) was trading around $550 per contract. During the COVID-19 recovery, it was difficult to get lumber because of work stoppages and supply chain issues. This caused the price of lumber to skyrocket to a high of $1,670. But, as more and more people got back to work and supplies started moving, the price of lumber dropped and found a bottom around $458. Lumber has since rallied, and on Monday, it was testing $760.

One indicator for the lumber demand is homebuilding. Despite the lower building permits and housing starts, demand for lumber is still high. Homebuilders are having to make difficult decisions on which group to focus on. This is a good sign because it reflects high home demand no matter who is buying.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

Image Sourced from Pixabay

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