Homebuilder Downgrade A Tough Housing Market Harbinger?

Caution, warns a sell side analyst regarding homebuilder stocks, and the sector swoons.

As seen on Friday (Sept. 21), homebuilder equities took it on the chin in the wake of a downgrade from JPMorgan. The firm lowered estimates and ratings for five names. Of those downgraded, PulteGroup and MDC Holdings were lowered to underweight (generally viewed as a “sell” on Wall Street), while a trio of names — Meritage Homes, Century Communities and Beazer Homes — were taken to “neutral” from “overweight” ratings.

CNBC reported that the stocks as a group fell into low single-digit percentage points in the wake of analyst Michael Rehaut’s note, which downgraded the aforementioned names, saying that “we are becoming more cautious on the homebuilding sector” and “we expect the housing recovery to remain fairly tepid in 2019.”

For the builders themselves, orders are likely to soften into the back half of this year, while margins peak. As noted in The Wall Street Journal (WSJ), the permits are down around 6 percent.

However, beyond the confines of the builders (where the implication is that this is as good as it gets), what trends might be sussed out? The analyst(s) behind the JPMorgan note said that rising inventories of newer homes, tied to a slide in affordability, will hurt home prices. If home prices start to come down, that  of course  hurts the builders.

This might also hurt lenders. Yes, it might have to be a precipitous drop for banks to lose appetite for lending. Lower housing prices also mean less home equity, which shrinks an available lifeline of capital for homeowners. Cut off that lifeline, and might it be the case that consumer spending (on larger ticket items, of course) feels a jolt?

The mortgage rates are higher, too, which eats into affordability. The 30-year fixed rate is around 4.65 percent headed into the end of the month, per a weekly data update from Freddie Mac. That number is five basis points higher than the week before.

In terms of other numbers: Existing home sales slipped in August from last year in the same month, the sixth straight monthly decline. The seasonally adjusted rate, as determined by the National Association of Realtors, slipped by 150 basis points to 5.3 million homes annually. The sales pace was flat with July.

In terms of trends, “flat” and “down” are not what one wants to see if they are, for one, homebuilders or, two, people who want to sell homes and pocket gains that are sizable as they might be in a tighter market. The trend has been outsized, where nearly 80 months of gains seen in tandem with rising mortgage rates have priced at least a few buyers out of their desired markets.

The biggest trend afoot, however, may be the fact that job growth might decline to the levels of 150,000 jobs versus an average of 207,000 jobs logged monthly thus far in 2018, as JPMorgan noted. This indicates a slowdown in the “population growth” that can, in turn, sustain a robust housing market.

An analyst downgrade, then, can lead to a tale told that is larger than a few stocks.