After being out of favor for four years, homebuilder stocks have come back to life in recent months. Is this comeback for real or doomed to fade away as it happened last year?
We believe it is for real. Here are some of the reasons:
- First, macroeconomic fundamentals have been improving, especially job growth, the most important factor that determines housing affordability.
- Second, improving microeconomic fundamentals. New home inventories are declining and home prices are stabilizing. Industry leaders like Toll Brothers (TOL), Lennar (LEN) and MDC Holdings (MDC), and DR Horton (DHI) have been reporting better than expected results.
- Third, improving technicals. Trading volume has been improving across the industry, and some charts (e.g., Lennar's and Toll Brothers') look bullish.
- Fourth, large short positions [e.g., Hovnanian Enterprises (HOV), SPF and MDC] may fuel a short squeeze, once homebuilder stocks break certain technical thresholds. Close to 41 percent of Honvanian's shares and 37 percent of Standard Pacific, for instance, are short.
- Fifth, record low mortgage rates (3.59 percent on a 30-year mortgage). But which homebuilder stocks offer the best appreciation potential?
Conservative investors may want to bypass this question by buying an ETF investing in homebuilder stocks like SPDR Homebuilders (XHB) and iShares Dow Jones Home Builders (ITB), or buy the shares of diverse homebuilders like D.R. Horton, MDC holdings and Ryland Group (RYL). Aggressive investors may want to accumulate the shares of individual homebuilders that have been taking steps to address the housing crisis early, like Lennar Corporation, Toll Brothers, Standard Pacific (SPF), and HOV, though due diligence is recommended.
A word of caution: A homebuilder comeback doesn't mean that the industry is heading for the old bubble days. Credit is still tight for people with low credit scores and unemployment remains above eight percent. This means that whatever gains from this point on are to be moderate.