Homebuilder stocks are set to conclude 2023 with their most significant annual gains in over a decade, defying expectations amid soaring mortgage rates. Despite the unusual challenge posed by rising interest rates this year, the tight housing inventory and relentless demand propelled homebuilder shares to a staggering 79% increase, far exceeding the S&P 500 Index’s 24% gain.
With bond yields on the decline, analysts on Wall Street are optimistic that this remarkable rally will extend into 2024. Seaport Research analyst Kenneth Zener, who accurately forecasted the sector’s performance for two consecutive years, believes that, regardless of the Federal Reserve’s approach to the economy, the expected rate cuts will enable homebuilders to outperform the broader market. Zener currently maintains a buy rating on all but one homebuilder stock.
JPMorgan analyst Michael Rehaut shares this bullish outlook, expressing confidence that recent earnings estimate revisions and increased price targets may prove to be conservative. Bank of America analysts, led by Rafe Jadrosich, anticipate improved supply chain dynamics in the coming year, with lower rates boosting sales and margins as builders reduce incentives. Citigroup’s Anthony Pettinari argues that the market has not fully priced in the expected rate declines for 2024.
Even in the scenario where lower rates lead to a shift in sales from new to existing homes, builders are well-positioned, according to Zener. Existing homeowners looking to sell will contribute to sustained demand. Stuart Miller, Lennar Corp.’s co-CEO, describes it as a “zero-sum game.”
Seaport’s analysis shows that the sector has historically outperformed the S&P 500 when rates are falling in nine out of 10 instances since 1957, except during periods of high resale inventory. Currently, there is no expectation for supply to outpace demand.
However, BTIG analyst Carl Reichardt issues a warning, suggesting that the sector may have reached its peak. Reichardt notes that the majority of the stocks he covers are fairly valued, and investors will require better-than-expected earnings growth in the long term. The upcoming spring season, a prime period for buying and selling, will serve as the next catalyst, with interest rates playing a crucial role.
“If rates fall and continue to fall, it’s entirely possible that the assumptions Wall Street has built about sales rates could be too low, and builders could see better business, therefore better earnings,” said Reichardt.
It’s important to note that homebuilders are early-cycle stocks, and any initial bearish economic or rate revisions may disproportionately impact the group, according to Zener. In the event of increasing recession risks, he envisions a brief two- to three-month drawdown followed by a significant rally, reminiscent of the trend observed in 2023.
