U.S. Homebuilders: Stay Overweight

The cyclical forces underpinning the outperformance of the U.S. S&P Homebuilding equity index remain upbeat, although the likelihood of a technical correction has increased.

U.S. Homebuilders Stay Overweight

T he consensus on U.S. homebuilding stocks has shifted from bearish to bullish in only two quarters. Late last year the relative price/book ratio was below average and net earnings revisions were contracting. Now, both are pushing optimistic extremes. Technical conditions are also overbought.

According to our U.S. Equity Strategy service, both valuations and technical conditions are extended for good reason. Demand for new homes is gathering momentum after a record-breaking slump. Homebuilders report a marked increase in new traffic, consistent with new homes taking market share away from existing homes. Also, sales expectations are steadily firming, heralding an acceleration in homebuilder new orders. Importantly, mortgage delinquencies and foreclosures have subsided, existing home prices have rebounded and the supply of existing homes has been run down considerably.

The path forward is likely to be marked by periodic waves of existing homes coming onto the market every time prices appear to be increasing, underscoring a bumpy road ahead. But the higher existing home prices climb, the greater the likelihood that new homes will continue to regain market share.

All of this is supportive of a continued cyclical outperformance phase, but this year’s pace to date is unlikely to be sustained, and is now more vulnerable to a bout of profit-taking should momentum in the new housing market stall.

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