New Home Sales were reported running at a stellar annual rate in October, and yet the shares of homebuilders and other real estate relative stocks fell sharply on the day of the report. Here's why…
Real Estate Relative Stock
SPDR S&P 500 (SPY)
SPDR S&P Homebuilders (XHB)
K.B. Home (KBH)
D.R. Horton (DHI)
Toll Brothers (TOL)
Bank of America (BAC)
Annaly Capital (NLY)
Judging by the exaggerated underperformance of real estate relative stocks last Wednesday you might have thought it was a bad day for housing data, but it was not. While the S&P 500 was down just fractionally on the day, homebuilders, housing lenders and dealers in mortgage securities, among a large group of real estate relative stocks, declined sharply. The nation's largest builder, PulteGroup, led the way in its decline of 2.4%. The nation's most important mortgage lender, Bank of America, was off 1.3%. Annaly Capital, the widely held mortgage REIT, dropped 0.6%. It was a bad day all around; but was it really?
New Home Sales were reported running at an annual pace of 444K in the month of October. That was well above the also just reported September rate of 354K (late due to government shutdown). Economists had foreseen a strong level of sales for October, but the consensus forecast was still short of the amazing actual result by 19K. The Midwest and South showed the best rate of increase over September, but every region of the nation reported impressive double-digit growth. Don't forget also that the Northeast and West are the two largest and established real estate markets, so growth in new home sales are harder to come by within them.
Growth in October over September 2013
So if the industry relative data was strong, the reader must be wondering why real estate relative stocks collapsed on the day of the report. You can look to the Beige Book for your catalyst. The market interpreted the Federal Reserve report, which was also released on Wednesday, in a way that would threaten the path of real estate market development. It was not because of a failing economy, though, but rather due to a steadily improving one. The concern among real estate sector investors is that the Federal Reserve will keep to its promise to taper back asset purchases if the economy continues to show significant enough improvement. That means less demand for mortgage backed securities and higher mortgage rates. Investors found in the Beige Book Report what seems to fit that perspective, and so they sold off the housing and real estate relative stocks despite the strong new home sales data.
Interest rates increased sharply on the day, and with them, mortgage rates. You can see in the daily Treasury Rate data that 30-year treasury rates increased by 6 basis points on Wednesday December 4th alone. Likewise, you can see within the weekly mortgage rate data that rates for 30-year fixed rate mortgages were up 11 basis points through the week ended December 4, 2013. When the news is reported for this week, it will likely show even higher mortgage rates.
Higher mortgage rates are bad news for a real estate sector that has desperately needed the government's support to find traction post the real estate collapse. Paying due credit to the latest and greatest Employment Report, the economy still seems burdened by a secretly still unemployed sector of America, which is now found within the pool of people collecting disability or welfare support or off the employment radar completely after having come out of the workforce count. Thus, housing enthusiasts have rightfully lost some optimism. The pool of those qualified to get a mortgage is likewise stifled somewhat by a still careful lending sector that has the watchful eye of regulators upon it now.
With this perspective, we can understand now why housing relative stocks declined on a day when new home sales ran up to a much better annual pace. From this analyst's perspective, the taper will come relatively soon, and it will still result in higher interest rates and a drag on the businesses of these real estate companies and also their stock shares. So in my view, last Wednesday offered us a glimpse into what is to come.