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Investment Ideas Rate drops could boost U.S. housing stocks, but risks remain

Lower U.S. interest rates could help support outperforming U.S. homebuilder stocks, even as they raise worries about the economy, while a bonanza of industry data and Federal Reserve speakers this week are likely to help shape the outlook.

After underperforming in 2018, the PHLX Housing Index is up about 30 per cent for the year so far, roughly double the year-to-date gain of the benchmark S&P 500 index.

Mortgage rates have been declining with U.S. Treasury debt yields, and the outlook for interest rates suggests further easing after the Federal Reserve lowered rates last month and indicated it could cut again this year, depending on data.

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Last week, U.S. 30-year Treasury yields fell to a record low below 2 per cent, while benchmark 10-year yields declined to a three-year trough as trade tensions linger and global economic growth continues to slow.

The 30-year fixed mortgage rate has dropped to 3.60 per cent from a peak of 4.94 per cent in November, according to mortgage finance agency Freddie Mac. Mortgage rates are often tied to the benchmark 10-year Treasury yield.

Strategists said that could bode well for homebuilders and the housing market, which has been struggling because of land and labour shortages.

A report on Friday showed U.S. homebuilding fell for a third straight month in July amid a steep decline in the construction of multifamily housing units, even as the data provided a positive sign for housing: a jump in permits to a seven-month high.

This week, the U.S. Commerce Department will release data on July new home sales.

Housing and homebuilding stocks should continue to do well as long as rates remain low, but the potential for slower demand is a risk, said Michael James, managing director of equity trading at Wedbush Securities in Los Angeles. “Lower interest rates lead to lower mortgage rates [which] lead to increased demand for homebuilders,” he said. “You counter that with potential concerns that, if a recession is coming, even if rates are at historically low levels, demand for everything is going to be somewhat mitigated.”

Eric Marshall, portfolio manager at Hodges Capital Management in Dallas, has seen relatively good traction in housing even with the turbulent markets. Lower rates are a plus, he said, along with an unemployment rate at its lowest level in years.

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“Consumer savings have come up, household formation continues to grow faster than the supply of housing,” Mr Marshall said. “And I think all of those things coming together make for a more stable environment for the publicly traded housing stocks.”

Recent results from some top homebuilders were mostly stronger than analysts expected, but some forecasts disappointed investors, underlining persisting problems in the housing market.

Last month, PulteGroup Inc. forecast full-year home sales and gross margins below analyst expectations and cited rising land costs, while in June, Lennar Corp. forecast current-quarter earnings below Wall Street estimates and noted uncertainty triggered by the U.S.-China trade war.

Multiples for some of the homebuilder stocks have jumped this year, but many remain below long-term averages. The S&P 500 homebuilding index, which includes PulteGroup, D.R. Horton and Lennar, is trading at about 9.5 times forward earnings, up from about 7 at the start of the year but well below a long-term average of 14.6, based on Refinitiv’s data.

Wedbush analysts in a research note on Thursday said that builders have been reducing square footages as mortgage rates have declined, which has addressed affordability issues. The firm has a bullish bias on homebuilder shares, with an “outperform” rating on William Lyon Homes, Beazer Homes USA, Lennar and others.

Investors will pay close attention to comments from Fed Chairman Jerome Powell, who is set to give a speech on rates and policy at the annual Jackson Hole, Wyo, policy symposium.

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“The fact that the Fed has moved to a more dovish position suggests that those rates should remain relatively low compared to what … we saw in late 2018,” said Robert Dietz, chief economist for the National Association of Home Builders.

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