The U.S. housing market has only recently begun to stir from the depths of a deep depression and already some observers are arguing the recovery is out of control, adding the sector to the long list of perceived asset bubbles.
The more likely scenario is that the recovery is just getting going, which adds to the upside potential for U.S. financial and homebuilding stocks.
Any way you size up housing, it has been pummelled since 2006 with little sign of anything but a modest – perhaps even tentative – recovery since then. Indeed, the recent recovery looks impressive only if you ignore the steep slide that preceded it.
Home prices, according to the S&P/Case-Shiller index for 20 cities, rose in January by 8.1 per cent, year-over-year. That was the biggest increase since 2006, when the U.S. market was near its peak.
But if that looks like out-of-control enthusiasm, some longer-term perspective is needed; prices remain some 29 per cent below their record highs.
Karl Case, the Wellesley College economics professor whose name is attached to the Case-Shiller home price index, told Bloomberg News last month that the January price uptick looked “nice and stable to me” – at least compared with the runaway gains seen a decade ago.
New and existing home sales, which reflect market activity, are following a similar path to home prices.
Existing home sales have rebounded 44 per cent from their lows in 2010 but are more than 30 per cent shy of their highs in 2005. Similarly, new home sales have rebounded 37 per cent from their lows, but are 69 per cent below their highs.
In other words, the U.S. housing market is recovering but home buyers aren’t exactly tripping over each other in a rush to scoop up homes on the cheap.
The stock market reflects this view. Homebuilding stocks within the S&P 500 have surged 370 per cent from their lows in 2008, when only the most intrepid investors considered the sector safe from annihilation. While that gain might look unrealistic, the preceding slide was far more remarkable: The sector is still 55 per cent from its high in 2005.
That leaves plenty of upside for investors willing to bet the recovery will stay on track, and that’s before we consider the growing U.S. population – up 15 million since the peak of the housing bubble in 2006, according to the Census Bureau.
Homebuilding stocks are the most direct way to tap into this trend. PulteGroup Inc. trades at 17-times estimated earnings – cheap for a recovering sector – and returned to profitability last year. Lennar Corp. trades at a steeper 24-times estimated earnings, but has been consistently profitable since 2010. D.R. Horton Inc. trades at 23-times estimated earnings and has been in a profitability streak since 2011.
U.S. financials also stand to benefit from an improving housing market. Financial stocks within the S&P 500 have nearly tripled from their lows in 2008.
Some observers might see a bubble there, too. But given that the sector is only halfway back to its highs in 2007, the froth is hard to see.