ETFs
Pain or gain ahead of home construction ETFs? – June 20, 2024
U.S. homebuilders’ confidence in the market for newly constructed single-family homes fell to 43 in June, down two points from May, according to the National Association of Home’s Housing Market Index (HMI). Builders (NAHB)/Wells Fargo published June 19. This is the lowest figure since December 2023.
“Consistently high mortgage rates are keeping many potential buyers on the sidelines,” said Carl Harris, president of NAHB, a custom home builder in Wichita, Kansas. The sector is grappling with higher rates for construction and development loans, prolonged labor shortages and a lack of land.
The Fed has encountered difficulty meeting its 2% inflation rate target due to lack of progress in reducing housing inflation, which currently stands at a year-over-year rate of 5.4% . This has hurt consumers’ buying frenzy and builders’ confidence.
iShares US Home Construction ETF (Quick quote ITBITB – Free report) is up about 2% and SPDR S&P Home Builders ETF (Quick quote XHBXHB – Free report) gained 10.8% this year. Both underperformed iShares Core S&P 500 ETF (Quick quote IVVIVV – Free report) by 15.7%. Let’s see if these funds can bounce back.
Price reduction and sales incentives
The June HMI survey revealed that 29% of builders cut home prices to boost sales, the highest share since January 2024 (31%) and well above May’s 25% rate. However, the average price decline in June remained stable at 6% for the 12th consecutive month. Additionally, the use of sales incentives increased from 59% in May to 61% in June, the highest share since January 2024 (62%).
In June, the housing market index of current sales conditions fell three points to 48, the indicator of sales forecasts over the next six months fell four points to 47, and the traffic indicator of potential buyers fell two points to 28.
What awaits us?
Recent inflation and retail sales data have ignited market expectations for an interest rate cut this year, with a 57.9% chance the Fed could cut the rate to between 5% and 5%. 25% in September, according to the CME FedWatch tool. And there is a 44.2% chance that the Fed could cut its rate to between 4.75% and 5.00% in December.
According to Fannie Mae, as quoted on Yahoo Finance, the 30-year mortgage rate is expected to end 2024 at 7% and will continue to decline throughout 2025, ending the year at 6.60%. According to Yahoo Finance, the Mortgage Bankers Association gave a more optimistic estimate for mortgage rates, predicting that the rate would end the current year at 6.5%, and would fall further in 2025 to 5.9%.
Optimistic industry and sector rankings
THE Zacks Building Products – Home Builders Industry contains many of these stocks and currently ranks in the top 14% of approximately 250 sectors. Because it ranks in the top half of all Zacks Ranked industries, we expect this group to outperform over the next 3 to 6 months. This group has been moderate this year with gains of just 0.1%, but could soar thanks to the possibility of interest rate easing.
Quantitative research studies suggest that about half of a stock’s future price appreciation is due to its industry grouping. In fact, the top 50% of the Zacks Rank industries outperform the bottom 50% by a factor of more than 2 to 1. Not only is the industry ranking optimistic, but homebuilders are from A Zacks Construction Sectorwhich ranks among the top 19% across approximately 16 sectors.
Compelling assessment
The homebuilding sector trades at a forward P/E of 8.33X versus 18.50XP/E for the S&P 500 ETF IVV. The sector’s price-to-book ratio is also favorable at 1.35X compared to 3.85X held by IVV. The industry’s price-to-sales ratio is also favorable at 0.93X, compared to the IVV ratio of 2.73X.
Good financial prospects
The industry’s projected EPS growth is 6.61% versus 6.64% IVV, while historical EPS growth was 34.53% versus 9.87% IVV growth. The residential construction sector’s historic sales growth (12.50%) was also higher than that of IVV (8.25%).
The sector’s return on assets is 10.60 times, compared to 6.88 times for IVV. The return on investment for home builders is 14.41 times, compared to 10.94 times for IVV.