Housing Stocks Are Ripe for a Pullback

Charts I’m Watching:

The shares of housing companies are ripe for a pullback…

Homebuilding stocks have been on a tear. The SPDR S&P Homebuilders ETF (XHB) is up almost 63% over the last two years. This is despite the Federal Reserve having raised interest rates by 525 basis points to 5.5%.

And there’s a big reason why… housing supply hasn’t been able to keep up with demand. To see what I mean, let’s look at a couple of key figures.

The first is household formation data. It’s published monthly by the U.S. Bureau of Labor Statistics (“BLS”). It stands for the number of individuals establishing a new residence like an apartment house, or other dwelling. We want to look at this figure as our demand side of the equation …

Based on the most recent numbers, new households are being formed at a pace of roughly 1.3 million per year. That’s in-line with the average rate of growth we’ve seen since 2010.

The next number we want to observe is housing starts. It’s published monthly by the U.S. Census Bureau. It measures the number of single-family houses, townhouses or condos, and apartment buildings with five or more units (each counted separately), on which construction has started. We want to look at this figure as our supply side of the equation…

As you’ll notice in the above chart, the most recent number for February was an annualized rate of 1.5 million. But, the typical pace of housing starts since 2010 has been roughly 1.1 million per year. That means the need for homes has outstripped the new supply being built by roughly 200,000 per year since 2010.

Here’s what the two sets of data look like over time…

As you’ll notice, the number of houses being built has remained relatively steady while household formation has not. The major outlier is the huge jump in demand (blue line) that started in January 2020 and ended in March 2021. The pace of household formation hit a peak of roughly 5 million in July 2020 before easing once more.

The change caused new home sales to explode higher. As you’ll notice in the following chart, the purchase pace shoots straight up from 570,000 in April 2020 to a peak of just over 1 million in October of the same year…

But then the Fed threw fuel on the fire. In late 2021 it signaled inflation growth was too high. Policymakers told the public it would soon have to start raising interest rates to cool the economy and get price pressures under control.

The language pushed fence-sitters into action. Anyone waiting for home prices to drop decided it was better to lock in cheap rates while they still could. And as you’ll notice in the next chart, housing prices shot up as a result…

From April 2020 to the peak in October 2022, the average price of a single-family home rose from $310,000 to $497,000. That’s a gain of just over 60%. The change exceeded the 52% increase in the decade prior.

But lately, the dynamics are starting to change…

Now, if we go back to the household formation chart at the top, we’ll notice something interesting about the trend. The annualized rate for December shows it has fallen back to the long-term average. In other words, it’s back to levels we haven’t seen since before the COVID pandemic.

And, if we return to the housing starts chart, we’ll notice another recent trend. Construction keeps rising despite easing demand. February’s annualized rate of 1.5 million new homes is 400,000 greater than the long-term average.

The change is starting to materialize in the form of increased housing availability…

After two straight years of steady decline, the total supply of single-family homes is starting to rise. According to BLS data, the total number of single-family homes hit 3.9 million in February…

That’s a gain of about 32% compared to the trough of 2.9 million in January 2023. In fact, February’s number is the highest we’ve seen since December 2020, when demand was skyrocketing.

Another way we can observe this is through the available supply in terms of month…

According to the National Association of Realtors, there were enough single-family homes for sale in January to satisfy 3.5 months’ worth of demand. That compares to the trough of 1.9 months back in February 2022. And, it’s close to the average inventory level of 3.9 months since 2012.

All of this is starting to show up in pricing. If we circle back to the median new home sales price chart, we can see the change. At the peak in October 2022, the average price was at $497,000. Today, that number has dropped back to $413,000, or a slide of 17%.

It’s likely that in the coming months, the drop will accelerate. As we discussed, the dynamics of the underlying drivers are changing. The pace of household formation is slowing just as builders are increasing starts to meet the demand.

Now, it doesn’t mean we’re in for an economic collapse. We’re far from it. But what the situation does imply is that the supply and demand equation is finally balancing out. And as that happens, it will place downward pressure on house prices, especially if the Federal Reserve keeps interest rates where they are. That’s likely to weigh on the shares of XHB and housing stocks in general.

But eventually, as housing affordability improves, either from a drop in prices, rate cuts, or both, it will underpin steady demand for housing and support long-term economic growth.

Five Stories Moving the Market:

Bond traders are stepping up short bets against Treasuries and buying derivatives to protect against a selloff, positioning for the risk that the Federal Reserve will dial back the market’s expectations for interest-rate cuts this year - Bloomberg. (Why you should care – if the Fed dials back rate cut expectations, it’s a signal of a healthy economy)

Bank of America Chief Executive Officer Brian Moynihan said the current quarter has been strong for its trading business and investment banking revenues across the industry have stabilized; Chief Financial Officer Alastair Borthwick said earlier this month that the bank is on track to meet its previous guidance for net interest income – Bloomberg. (Why you should care – positive commentary from BofA about the investment and commercial banking businesses should bode well for other large-cap investment banks)

U.S. single-family homebuilding rebounded sharply in February, hitting the highest level in nearly two years, boosted by mild temperatures and a persistent shortage of previously owned houses on the market – Reuters. (Why you should care – strength in the homebuilding sector should continue to underpin economic growth)

The pressure on Canadian wallets eased again last month with the annual pace of inflation decelerating to its slowest in eight months; consumer prices rose 2.8% in February from a year earlier compared to economists’ expectation for an advance to 3.1% - WSJ. (Why you should care – the data point to the potential for further easing of inflation growth in the U.S.)

China left benchmark lending rates unchanged at a monthly fixing, in line with market expectations, after the central bank kept a key policy rate steady last week amid some signs of improvement in the broad economy – Reuters. (Why you should care – the lack of adjustment signals the government in Beijing is ok with current economic growth)

Economic Calendar:

China – 1- and 5-Year Loan Prime Rate

U.K. – CPI, PPI for February (3 a.m.)

Germany – PPI for February (3 a.m.)

ECB’s Lagarde (President) Speaks (4:45 a.m.)

ECB’s Lane (Chief Economist ) Speaks (5:30 a.m.)

MBA Mortgage Applications?(7 a.m.)

ECB’s De Cos Speaks (8 a.m.)

ECB’s Schnabel (Executive Board) Speaks (9:45 a.m.)

Energy Information Administration Crude Oil Inventory Data (10:30 a.m.)

Eurozone – Consumer Confidence (Preliminary) for March (11 a.m.)

ECB’s Nagel, Villeroy Speak (12:30 p.m.)

Federal Reserve Policy Announcement (2 p.m.)

Fed’s Powell Speaks (2:30 p.m.)