Buy homebuilders on the dip?
Support levels have been tested after the recent spike in interest rates. Can shares hold their ground here?
By Neal Rau
Home improvement stocks like Home Depot (HD) and Lowe's (LOW) have been beating earnings this week. The boom in home prices and demand for housing could mean continued strong earnings for the homebuilders, but a recent spike in rates has caused shares in companies like Lennar (LEN) and Toll Brothers (TOL) to decline. Mortgage applications last week showed a 5% decrease, so is this the time to buy the homebuilders on the dip?
Let's take a closer look.
Existing home sales climbed above the forecast in July. It appears that home buyers have been rushing into the market because they are concerned that mortgage rates could go higher.
Keep in mind, the existing home sales report is a lagging indicator of market activity and an existing home sale is not recorded until escrow closes. Many of the contracts may have been signed before rates spiked in May based on the 30 to 60 day process of escrow closing. Investors will be watching the mortgage application index closely, as that might be a better indicator.
The homebuilders are in the crosshairs of rising rates, and if future Fed statements are interpreted to suggest that QE will be ending soon, rates could spike even higher, meaning fewer people will be willing to take out mortgages on homes. The initial rise in rates in May motivated buyers to close deals, but if rates spike again, new buyers might be scarce. During the third-quarter conference call D.R. Horton (DHI) said that the spike in interest rates slowed the company's orders.
SPDR S&P Homebuilders (ETF) (XHB) has more than doubled in the last two years, and support held on the dip in May. Although the best buying opportunity may have already come and gone, a push towards resistance is likely.
The technicals (StockTraders) are offering a warning though, and that is based on support. If stocks like Lennar and Toll Brothers turn and fall below support, that will cause this otherwise positive bias to shift. We buy near support because support acts as a risk control measure for us, but thus far support has held. As long as it continues to do so, our analysis will have a positive bias.
Although housing demand remains strong, mortgage rates are at the highest levels in two years, and if rates spike again, buyers could dry up quickly. If July's numbers were propped up by buyers trying to close deals during the rate spike in May, next month's numbers could look much worse.
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