💵 As Safe As Houses

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The US housing market continues to confound and confuse. Search social media and plenty are still waiting for an '08 style crash.

However... 👇

Which, considering the supposed drag from higher interest/mortgage rates is a little surprising...

So, there must be a good reason, right?

Let's focus on two of the big guns. Lennar (LEN) and D.R. Horton (DHI). Some quick context from this Harvard paper  👇

TL;DR, they're the big guns. And the only reason DHI didn't post a new 52 week high yesterday is because it traded a smidge higher at the start of February...

So why would anyone want to own housing stocks if the real estate industry is on the verge of crisis?

Is the market just dumb, and can't see WHAT'S COMING...?

"I'm smart and the market's dumb" isn't usually a good strategy...

Homebuilders such as Lennar have sacrificed margins, but kept building regardless...

For Q1 2023, Lennar reported:

• New orders decreased 10% to 14,194 homes; new orders dollar value decreased 18% to $6.4 billion

• Backlog decreased 29% to 19,403 homes; backlog dollar value decreased 33% to $9.0 billion

• Net margin on home sales decreased 560 bps to 13.8%

In the earnings call, Miller explained the reason for the margin compression.

On top of this, he thinks that people are getting used to higher rates, plus input cost reductions will be able to offset any further incentives that will be required to keep sales ticking over...

This improving, optimistic sentiment ties in with the NAHB Index...

And, as we have repeatedly said, there's no real reason to panic over the housing industry right now. Yes, it's cyclical, but there are ways to bridge the gap from current higher rates to what buyers hope will be lower rates a couple of years down the line. 👇

But that still doesn't answer the original question... Why would anyone be buying homebuilders NOW near ATH's?

Goldman covered the sector recently. LEN's trading at $109, very close to the GS $112 price target. DHI is trading at $102, a little over Goldman's $99 price target...

Maybe you can make the case that they're solid companies with cash flows and operating profits, and/or that they should lead the recovery if/when the Fed pivots, but there's not a lot of margin for error here.

Maybe you buy them for the dividends? 

Lennar's dividend yield is currently 1.43%. Hardly groundbreaking, but it's something at least...

DR Horton's dividend yield currently sits just under 1% (subject to change - the company reports earnings tomorrow after the close).

Those dividends might not be too reliable going forward either. Jefferies screened for companies likely to disappoint on dividends (based on their view that slowing global growth, tight liquidity, higher rates and a profit recession will be significant headwinds to dividend strategies this year) and found Lennar as one of the most likely candidatesl...

So are these homebuilder stocks priced for perfection?

The immaculate disinflation, a soft landing, access to credit stays easy and open, lower mortgage rates soon, & low available housing inventories keep homebuilders ticking over, with only a very mild recession if there's even a recession at all...

I mean... Maybe?

But then, people said the same about the used car market too, and we'll see how tightening credit impacts there soon enough...

Credit tightening has definitely started and is expected to continue. Here's what Ally Financial said today:

i.e. We will be lending less, and/or charging more to lend (which amount to the same thing).

So, on the back of David's tweet here...👇

There might actually be more compelling shorts in the sector than the homebuilder ETF (once the worm finally turns). Homebuilders generally look vulnerable to bad news.

Signs of a genuine credit crunch, a re-acceleration of inflation, pricing out of 2023 rate cuts and/or long rates moving higher are key risks to a sector pricing something close to perfection.