2 Reasons Rate Rise Makes Homebuilders A Buy

Jun. 23, 2013 2:41 AM ETITB, XHB, PHM, DHI, LEN, TOL15 Comments
John Tobey, CFA profile picture
John Tobey, CFA

The sharp drop in homebuilder stock prices last week was based on the belief that interest rates up necessarily means home sales down. In today's environment, that logic is flawed. The correct evaluation should be that the rising interest rates will boost housing's comeback, not defer or diminish it. Therefore, those hammered homebuilder stocks give us a special opportunity.

Below is the six-month performance of largest four homebuilders (by market capitalization), showing the significant decline since interest rates started firming, then rising. The companies are PulteGroup (PHM), D.R. Horton (DHI), Lennar (LEN) and Toll Brothers (TOL).

(Performance chart courtesy of Barchart.com)

Two reasons why the rate rise will boost housing market

Yes, higher rates increase the cost of home ownership, but this housing market actually has been held back by the abnormally low interest rates. There are two reasons why the rate rise will enhance the housing market, not hinder it:

First, housing demand is created by the rate increase's psychological effect on potential buyers

In "normal" inflationary periods, an upward price trend produces a desire to buy sooner, ahead of the next price rise. The same psychological effect applies to interest rates and housing (again, in "normal" economic periods), so the rising rates should spur some buyers to act. However, there is more to the effect than that.

We are not in a normal period because: (1) The interest rate trend has been down; (2) the interest rate level is abnormally low; (3) the Great Recession's negative feelings have lingered, particularly as the Fed reinforced the notion that all was not well; and (4) the housing market (sales and prices), while up, are still well below normal.

But things have been changing, as seen by rising retail sales, increased consumer confidence and investor moves into stocks. Add to this improved environment the

This article was written by

John Tobey, CFA profile picture
I am the founder and editor of Investment Directions. My career has been managing and consulting to multi-billion dollar funds. Using the widely accepted “multi-manager” approach, I have worked with top investment managers throughout the country, gaining a high level of expertise. My career has spanned many market environments, and I have hands-on experience searching out opportunities and avoiding risks in all of them. I now devote my time to Investment Directions, with the goal of helping investors further their understanding and improve their investing skills. I am currently serving on: The AAUW Investment Advisers Committee and The City of Vista Investment Advisory Committee.

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