Housing stocks plagued by higher mortgage rates seeking alpha gas tax

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As some sectors seemingly continue to chug higher, such as small caps ( IWM), energy stocks ( XLE), and technology ( QQQ), other sectors have been left behind. The past several weeks have seen interest rates rise across the curve which has caused average mortgage rates to rise near 4.8%, the highest since 2013 after the ‘taper tantrum’. Housing stocks are typically very sensitive to interest rates. After a strong rally in 2017, with housing-related stocks up 60%, the tide has turned in 2018 as housing is one of the worst performers, down over 10% YTD. Homebuilder Stocks 2017 Vs. 2018 Performance:

Some may argue that the decline in housing-related stocks has most to do with getting overstretched in 2017 and the 2018 declines are a mere correction. Most of the housing-related economic data, as well as soaring mortgage rates, indicate that the decline in housing-related stocks is more than a benign correction.

If you take a $300,000 dollar home with 10% down ($270,000 mortgage), average payments at last year’s interest rates (3.6%) would be roughly $1,220. A 100 basis point jump in mortgage rates cause those same mortgage payments to raise nearly $200 per month, exceeding $1,400.

Rising interest rates have a material impact on home buying and the data is beginning to show the ripple effect from those increases. MBA mortgage application growth has been negative 6 out of the 7 last weeks. There has clearly been a material drop off in the interest for mortgages with the bulk of the damage coming in the past several weeks when interest rates suffered their worst few weeks in years.

Going back to the beginning of the year shows MBA mortgage applications down 10 out of 19 weeks. There has been a notable slowdown in the mortgage market which accounts for some of the declines in housing stocks. Sure, housing stocks got ahead of their fundamentals and were due for a pullback but the economic data suggests it is more than a simple correction. There is trouble brewing in this space and the rise in interest rates only makes that problem worse. Mortgage Application Growth:

Existing home sales growth has been decelerating for nearly three years and registered a negative reading as of the latest reporting period. Existing home sales represent 90% of the transaction volume in the housing market and to see decelerating growth, let alone negative growth is a troubling sign for housing. It is possible that the negative growth rates in the volume of existing home sales will not last, but to have 90% of the housing market in a contractionary territory from a volume perspective is a troubling sign. Prices are still rising at a rapid pace which offsets some of the worries surrounding declining transaction volume.

Newly constructed homes, the other 10% of the housing market, has held up much better in terms of volume growth. The year on year growth rate of new home sales is still positive although down notably from the 2015-2016 peak in the market. These are not flashing red lights just yet for the housing market but the slowdown or declines in volume and mortgage applications is noteworthy and can assuredly account for some of the declines in housing-related stocks. This is not all due to a standard price correction. New Home Sales Year over Year Growth:

Lastly, the growth rate in the number of houses currently under construction has fallen for the better part of three years since late 2013-early 2014. The chart below shows a smooth cycle of housing, inflecting positively late in 2009 and rolling over in 2014. Again, not a major red flag just yet but three years of deceleration, down to just 4% growth in construction, should pose a challenge for home-building companies. Housing Under Construction Year over Year Growth:

The economic data across the entire housing space, with the exception of sales prices, is decelerating. The growth rate is not at levels that should cause immediate concern, but a decelerating growth rate will absolutely hurt the stock prices of those companies tied to housing market growth. 4% growth may sound okay, but if a company reported earnings during a period of 15% construction growth, an environment of only 4% growth is likely to pose a challenge in showing robust top and bottom line growth compared to quarters prior.

Top homebuilder companies such as Lennar ( LEN) and D.R. Horton ( DHI) were routinely posting top-line revenue growth well above 20% and sometimes as high as 50% year over year. With the decelerations in the housing data, coupled with higher mortgage rates which diminish the appetite for new homes, revenue growth at some of these companies has fallen in the single-digit range.

The peak in revenue growth came just before the peak in new home construction growth. The falling revenue growth compared to past quarters is definitely putting marginal pressure on the home-building stocks this year. Housing Related Stocks:

In summary, higher mortgage rates may have hit the housing market at the same time as a classic cyclical slowdown in the real-estate market. Homebuilder stocks are down nearly 20% peak to trough and almost in a bear market. This is more than a pullback due to overextended gains. Housing stocks, of course, got ahead of themselves in the 2017 rally and have given some of those gains back. I think the reasons behind the declines are much more rooted in fundamentals than in technical price corrections.