Some Strategists See Home Building Peak
By MEG RICHARDS
The Associated Press
Saturday, February 5, 2005; 7:25 PM
NEW YORK - Home builders have been among the best performing stocks over the last several years as consumers took advantage of historically low mortgage rates. But with monthly data suggesting a slowdown in sales of new homes and economists predicting an eventual rise in rates, it may be time to eye these stocks more critically.
The Dow Jones U.S. Home Construction Index surged an astronomical 588 percent over the last five years, making it the market's top performing industry. It's been a leader over the last three months as well, rising 28.4 percent. And several housing stocks catapulted to new all-time highs Friday after bond yields sagged on a government report showing sluggish job growth in January.
But as hot as the housing market seems, its long run higher and signs that slower growth may lie ahead have put some professional investors on their guard. For individual investors who own these stocks, it may be time to think about collecting profits.
"We've begun to get cautious on them. We've told people to trim. Not to sell them outright, but to consider trimming, winnowing down, and take some money off the table," said David Darst, chief investment strategist with Morgan Stanley's individual investor group. "You might miss some, but you've had this big run, and the price potential is somewhat limited from here."
Darst points to the "parabolic price increases" of home builders - on a chart, the line tracking their performance is practically vertical. For some bears, it's an uneasy reminder of the run-up tech stocks enjoyed before their 2000 slide. The skyrocketing pace has raised worries that housing stocks have surged beyond their underlying fundamentals.
"Some people think it could go further, but that reminds me of the talk in '97, '98, and '99," Darst said. "People who got out too early were kicking themselves, but a few years later, they were feeling better than the people who overstayed the party."
On top of that, slower-than-expected new home sales in December, following a steep drop in November, suggest the housing market may finally be starting to cool. And while average rates on 30-year fixed mortgages just fell for a fifth straight week to 5.63 percent, most economists believe they will rise eventually, as the Federal Reserve presses ahead with a policy of gradually tightening short-term rates.
Adopting a cautious tack might be a challenge as industry leaders like D.R. Horton Inc., Pulte Corp., Centex Corp., Lennar Corp. and Toll Brothers Inc. strike new highs. And it's worth noting that Wall Street has been wrong about this before; many analysts warned that higher rates would cause declines in housing stocks and real estate investment trusts last year. But the market defied their predictions, and long term rates stayed low even as the Fed tightened short-term rates. A record 1.18 million new homes were sold in 2004 - an 8.9 percent rise - and the median price went up 12.3 percent to $218,900.
On a $200,000 mortgage, at the current 30-year fixed rate of 5.63 percent, the monthly payment for principal and interest would be $1,152, according to the handy mortgage calculator at www.dinkytown.net. If long-term rates rise to 6.5 percent by the end of the year, as expected by some economists, including David Seiders at the National Association of Home Builders, that payment would come to about $1,264 - an annual increase of $1,344.
Paying that much more might not discourage every buyer, but it could trim home sales by about 3.5 percent, according to Seiders. Even with that kind of decline, the country would see its second-best level of new home sales ever. But if rates rose more rapidly, due to some sort of external shock, it would cut home builders more deeply.
Those who remain bullish on the industry point to relatively low price-to-earnings ratios, strong revenue and earnings visibility, solid consumer demand, and the fact that most of the large, national builders are broadly diversified enough to withstand whatever downturn comes as rates rise.
Still, even though none of the signals are screaming to investors to sell, many analysts suspect the trend has peaked. If you don't own these stocks, it's not a great time to be buying them, said Brad Sorensen, sector analyst at the Schwab Center for Investment Research.
"We think the greater risk is on the downside, rather than a risk of missing a large upside move," Sorensen said. "There are more attractive places to put your money right now."
If you do own them, you should look very carefully to see how well diversified your holdings are, both geographically and in the products they're building. The bigger, more diversified players that have been most aggressive about moving into new markets are most likely to be long-term winners.
"The large builders have positioned themselves in a way that they are likely to continue to grow their bottom lines in a weakening housing market," said Gregory E. Gieber, stock analyst with A.G. Edwards & Sons, Inc. "They are becoming like big box retailers, forcing out of business, as the housing market weakens, the smaller main street builders. As things become tougher in the industry in '05, you're going to see the cost advantages that the big builders have really come home to roost."
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