Homebuilders Update
In a recent interview with CNBC, Warren Buffett changed his outlook on the economic growth in the U.S. Previously, he had said that "the economy and jobs will come back big time when residential construction recovers". Now, although he remains bullish on a recovery in residential housing, as is evident from his words "we're seeing a pickup, and it's noticeable", he has said that the U.S. economy is "more or less flat".
Amid the global uncertain economic environment, the housing sector is showing healthy signs of improvement, after it experienced a continuous downturn since the subprime mortgage crisis of 2007-08. With mortgage rates floating around record-low levels, pending-home and new-home sales peaking to two-year highs, a more-than-expected increase in the 20-city S&P/Case-Schiller composite index, and an increase in residential construction spending, the sector is expected to rebound.
Warren Buffett also continues to remain optimistic about the housing sector's recovery, although he feels that the growth in the overall U.S. economy has been almost flat. Recently, U.S. lenders have taken steps to reduce the backlog of homes, by increasing foreclosures of delinquent homes. This will help the industry recover quickly, although the recent reduction in mortgage applications has been a slight pullback.
We reiterate our recommendation of long positions for the stocks of major homebuilders Lennar Corp (LEN), Toll Brothers (TOL), DR Horton (DHI), and KB Homes (KBH), as they have shown (in their latest earnings releases) an increase in the number of orders and quarterly backlogs, along with a reduction in order cancellation rates. If a risk-averse investor wants to hedge its long positions in homebuilders, a potential candidate for taking a short position can be the homebuilders ETF (XHB).
LEN | TOL | DHI | KBH | |
Increase in number of new orders (% YoY) | 40% | 47% | 19% | 3% |
Increase in Quarterly backlogs (% YoY) | 61% | 37% | 17% | 22% |
Decrease in Order Cancellation Rate (% QoQ) | 2% | 3.80% | 4% | 10% |
Yesterday, shares of major homebuilders fell significantly as a result of a fall in mortgage applications last week, even though the interest rates are hitting record low levels. As according to the latest weekly press release of the Mortgage Bankers Association, the seasonally-adjusted index of mortgage applications activity (or the Market Composite Index), which incorporates purchase demand as well as refinancing activity, decreased by 2.1% last week. Major homebuilders like KBH, TOL, DHI, and LEN dropped by 3.79%, 2.17%, 1.97%, and 1.74% respectively, despite the fact that fixed 30-year mortgage rates have hit record-low levels (declining to 3.56% from 3.86% a week ago).
In addition, U.S. banks have increased notifications of foreclosures to delinquent homeowners, so as to clear the so-called shadow inventory of homes. These initial foreclosure notices have increased by 6% in the second quarter, as compared to last year. This will help the Housing Industry rebound at a faster pace, which further substantiates our previous bullish outlook on the industry.
To conclude, we continue to remain optimistic about the housing sector, and recent positive developments are expected to increase the pace of its recovery.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
