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The construction site of a new house in Alexandria, Va. (Kevin Lamarque/Reuters)
The construction site of a new house in Alexandria, Va. (Kevin Lamarque/Reuters)

Market View

U.S. housing rebound offers room for profit Add to ...

A steady stream of upbeat reports on the U.S. housing sector is feeding a growing consensus that one of the most beaten-up areas of the economy is at last showing a pulse.

The latest report on housing starts from the U.S. Commerce Department dazzled observers on Wednesday, showing that home construction activity in June rose 6.9 per cent over the previous month, beating expectations and hitting its highest level in nearly four years.

Earlier in the week, a survey from the National Association of Home Builders showed that builder confidence jumped to a reading of 35, its highest level since 2007 and marking its biggest one-month gain in about a decade.

Okay, caveats abound. Despite rising confidence among home builders, they remain very cautious. Any reading below 50 suggests that more builders believe conditions are poor.

As for the gains in housing starts, the level rose to an annualized pace of 760,000 last month. That is still a fraction of the sort of activity seen when the sector was buzzing prior to the financial crisis.

“Note that at these levels, starts are still well below the one million or so level that typically marked the bottom of a recession, so there’s a long way to climb before housing will take its typical role in economic activity,” said Avery Shenfeld, chief economist at CIBC World Markets.

Still, he said housing is the one bright spot in the U.S. economy right now, and the stock market seems to agree.

U.S. home-building stocks have been the top performers within the 154 industry groups in the S&P 500 this year, rising 54 per cent. The sector – consisting of Toll Brothers Inc., D.R. Horton Inc. and Lennar Corp. – has now tripled in value from its low, in 2008.

Stocks related to housing are also seeing gains. Building materials stocks, such as Beacon Roofing Supply Inc. and Masco Corp., have risen 36 per cent each this year.

The question for investors is how much upside is left.

If you take the peak, in 2005, as an important reference point, then there seems to be plenty of room for the share prices to rise: Despite recent gains, the home-building sector is down nearly 70 per cent from this high point.

The problem is that this peak occurred during what was widely seen as a housing bubble, when homes were bought with zero down payments and consumers generally had no concern about massive debt loads.

This frenzied level of housing activity might never return. Perhaps this is why home-building stocks have been reluctant to rally from their current heights. Indeed, they have been treading water throughout most of July.

Still, there are a couple of reasons to feel that more gains can be had.

For one, home-building stocks in the S&P 500 trade at decade lows – or well below the levels seen at the start of the housing bubble. In other words, the bubble doesn’t have to re-inflate for share prices to rise.

Secondly, analysts remain cautious, with a mix of “hold” and “buy” recommendations. Even better, their consensus target prices are only pennies above current share price levels, which implies that analysts aren’t expecting anything too dramatic in the year ahead.

Low expectations can mean that share prices are not yet factoring in a robust housing recovery.

For sure, the sector has a long way to go before it can be called robust. But you better believe that stocks will reflect that condition well before it arrives.

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