My summer portfolio strategy is to play old disco hit Baby Come Back while slow dancing with my December brokerage statements. If it works out, I have a business idea involving Hall, Oates, and a 2 and 20 fee structure.
At least there’s real estate. Home equity is said to be at record highs. Then again, taking comfort there would be like donning a financial toupee, everyone knows the underlying conditions have deteriorated.
The last nationwide price reading was in March. Since then, 30-year mortgage rates have climbed to nearly 6% and buyer demand has slowed. Last week, a pair of online brokers with a good read on home searches,
(symbol: RDFN) and
(COMP), announced layoffs.
Meanwhile, Redfin shares are down around 90% from their peak. Builders were also frazzled. Friends don’t let friends own leveraged exchange-traded funds with names like
Direxion Daily Homebuilders & Supplies Bull 3X Shares
(NAIL), especially when interest rates rise, but if you’re curious, this one just lost 45% over five trading days.
Should investors buy homebuilder stocks here? Brokers? What future for real estate prices? And when will the stock market return? Let me answer these in order of short-term decline in confidence, starting with uncertain.
Yes, buy builders. Favorite
(TOL), says Jade Rahmani, who covers the group for KBW. He points out that builder stocks are trading at 60% of projected book value, which is their lowest point during recessions, ignoring the 2008 financial crisis. Lennar will benefit from the ongoing sale of a technology unit real estate, and Toll focuses on affluent buyers, about 30% of whom pay cash, and are therefore not put off by high mortgage rates.
Price-to-earnings ratios for the whole group are surprisingly low, but ignore them. They stem from two conditions that won’t happen again anytime soon: land values that jumped 30% or more between when companies bought acres and when they sold homes, and a pace of transactions significantly higher during the pandemic. A builder trading at four times earnings could really go up to eight times assuming normalized terms remain cheap, but a big difference.
House prices jumped more than 20% in March from a year earlier, but Rahmani expects that rate to plunge to 2% by the end of the year. His basic view is that next year will bring fixed prices. Its recession scenario, based on a study of past sales volumes, predicts prices will fall by 5% next year, possibly more if mortgage rates rise to 7%. It may not seem like much, but for recent buyers with typical mortgages, a 5% price drop can reduce equity by 25%.
Most homeowners don’t have mortgage rates anywhere near recent; about two-thirds are stuck below 4%. These buyers are unlikely to move and take out new loans if they don’t have to, which is one reason supply could remain low for years. Another is that mortgages are of much higher quality than they were during the last housing bubble, so there is unlikely to be a wave of defaults and panic selling.
But something has to overlook affordability. Typical payments on new mortgages have exceeded 23% of disposable income, near their peak of 26% during the last bubble. But incomes are growing at 6% a year, so a long pause for house prices could help restore affordability. Either way, the pandemic has left people spending more time at home, so they should be prepared to pay a bit more for housing as a percentage of their income, Rahmani believes.
Don’t rush to buy stocks from brokers, says William Blair analyst Stephen Sheldon. It has Market Perform ratings on three of them: Redfin,
eXp World Holdings
(EXPI). In a blog post last week, Redfin CEO Glenn Kelman wrote that May demand was 17% below expectations and the company would lay off 8% of employees. Redfin hires agents directly, whereas many brokers use independent contractors.
Kelman wrote that the sales slump could last for years rather than months. More agents could leave on their own. Membership in the National Association of Realtors, an indicator of the number of people selling homes, hit 1.6 million last year, up from around 1 million in 2012.
William Blair’s Sheldon says he’s been hit by falling broker valuations, but the sentiment is sour and he’s waiting for signs of stabilization. Redfin is going for less than a tenth of its peak market value at the start of last year, even though earnings have roughly doubled. That puts stocks at about a third of earnings. Free cash flow was expected to become consistently positive from 2024. Now see.
As for the stock market, I have good news and bad news, none of which is reliable. Last week, the S&P 500 fell below 15 times expected earnings for next year, suggesting prices have returned to historical averages. But there is no reason to say that the market will not exceed its average valuation to become cheap. And
says earnings growth forecasts of 10% this year and next seem too high.
Expect slower growth, Goldman says, and if there is a recession, profits next year could fall below last year’s level. Bank estimates under this scenario leave the S&P 500 trading today at more than 18 times next year’s earnings. Goldman predicts the index will rise 17% from Thursday’s level by the end of the year without a recession, or fall 14% with one. Please accept my congratulations or condolences.
Don’t worry, says Credit Suisse. Statistically, individual corporate earnings forecasts are closely clustered. This is the opposite of what tends to happen before the profit pool.
I’ve heard people talk about the stock market as a total cluster before, but I didn’t know they were talking about the dispersion of estimates.
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