Home builder stocks are experiencing their strongest week since late last year due to the decline in U.S. Treasury yields. This decrease in yields could potentially result in a retreat in mortgage rates, which is just one of the factors driving the surge in these stocks, according to industry experts.
Impressive Performance by Home Builder ETFs
The two prominent exchange-traded funds (ETFs) that track the home builders and related industries, the SPDR S&P Homebuilders ETF (XHB) and the iShares U.S. Home Construction ETF (ITB), achieved significant gains on Thursday. XHB closed with a 2.17% increase, while ITB saw an impressive jump of 3.42%. Dow Jones Market Data reveals that this marks their highest closing numbers since October 11. This week alone, these ETFs have already surged by approximately 8.1% and 9.6%, positioning them for their most exceptional performances since November last year.
Reversing a Downward Trend
The recent surge in home builder stocks counters the extended decline they faced during the second half of the year. Higher mortgage rates negatively impacted potential buyers, sellers, and builders alike. However, Freddie Mac reports that mortgage rates have started to slightly decrease after rising consecutively for seven weeks, hitting a 23-year high.
Influence of Treasury Yields on Mortgage Rates
The decline in mortgage rates can be partly attributed to the slump in the 10-year Treasury yield, which often has an impact on mortgage rates. Investors have been particularly enthusiastic due to the significant drops recorded in daily mortgage rates this week, as reported by Mortgage News Daily. Thursday saw a decline from 7.69% on Wednesday and 7.88% on Tuesday to an impressive low of 7.51%.
Overall, the combined effect of lower mortgage rates and slumping Treasury yields has generated substantial optimism in the home builders' market, propelling stocks to their current impressive heights.
Housing Market Trends
In a housing market characterized by exorbitant costs and a limited supply of homes for sale, builders have reason to rejoice as lower mortgage rates come into play. While the sales of previously owned homes face challenges, new home sales have remained robust. With a scarcity of available homes, buyers are increasingly turning to builders for expanded options. Furthermore, builders can entice buyers with incentives such as mortgage rate buydowns, which are less common in sales of existing homes.
Attractive Investment Opportunities
According to Seaport analyst Kenneth Zener, builder stocks currently present a favorable investment opportunity due to their relatively cheap valuations. Zener has upgraded five midsize home builders—KB Home, M.D.C. Holdings, Meritage Homes, Taylor Morrison Home, and Toll Brothers—from Hold to Buy ratings in his latest report. Remarkably, Zener now holds Buy ratings for all the builders under his coverage.
The 1x Book Value Indicator
Many builders are currently trading at around one times book value, which historically suggests a good time to buy. Zener highlights the long-standing investment strategy of buying builders at 1x book value and selling at 2x book value. However, Zener expects this playbook to remain valid unless there are significant pending impairments, which he does not anticipate. In the current market, he believes that book value heuristics outweigh other factors such as higher returns on capital, EPS matching cash flow, or lower leverage when it comes to justifying higher valuations for builders.
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