English: Lennar Corporation’s headquarters in Fountainbleau. (Photo credit: Wikipedia)
Some investors are sticking to their bullish bets on home builders, despite a number of warnings from Wall Street analysts that the massive rally in the stocks is overdone.
The optimists say they believe the recovery of the U.S. housing market still is in its initial phase, leaving plenty of room for the stocks to keep rising.
The gains so far have been startling.PulteGroup Inc., PHM +1.59% the largest U.S. home builder by revenue, is up 214% in the past 12 months, when new-home sales began rising consistently. It also is the best performer in the Standard & Poor’s 500-stock index over the past year. Lennar Corp.,LEN -1.31% the third-largest U.S. home builder by revenue, is up 117% in 12 months. In the same period, the S&P 500 is up 10%.
“Home sales tend to move higher over a five-year cycle, and this is year one,” says
Kirk Mentzer, director of investment research with Huntington Asset Advisors, a $14 billion fund in Columbus, Ohio. “There’s still a ways to go, even if the rise from here is just half of the current rally.” The firm bought D.R. Horton Inc., DHI -1.66% a home builder in Fort Worth, Texas, at the end of 2011, and is hanging on even after a 71% run-up this year.
Data in recent months have indicated the pace of recovery has accelerated. New-home sales jumped 5.7% in September to their highest level in over two years. The Commerce Department said recently that housing starts had risen to 872,000, the highest seasonally adjusted annual rate in four years.
Investors are more optimistic about the housing sector than they are about the broader economy, in part because of the recent action by the Federal Reserve to further bolster the market by purchasing mortgage-backed securities. Both analysts and investors expect the housing market to continue to improve, though they note that if the recovery comes to a halt, shares of companies sensitive to the housing market—including those of builders—are likely to sell off.
Investors have poured $653.7 million into the iShares Dow Jones U.S. Home Construction Index Fund so far in 2012, putting it in the top 5% of exchange-traded funds in terms of inflows, according to Morningstar.
And home builders have shown resilience during the recent swoon in the broader market. The Dow Jones U.S. Home Construction Index has lost 0.5% over the past two weeks, compared with a 3.3% drop for the S&P 500.
Mr. Mentzer and other bullish investors point to history to bolster their position. During the housing upturn from 2001 through the end of 2005, shares of custom builder KB Home KBH -2.12% surged 357%. Since September 2011, they are up a relatively modest 145%. And because the housing-market slump of recent years was the most severe on record, there is more room for home-builder shares to rise this time around, investors say.
Sorin Roibu, a housing analyst for money manager Turner Investment Partners, which oversees nearly $12 billion, believes with the labor market in the U.S. still slack, home builders will have an easier time managing costs in the current upswing. He expects bigger margins as a result.
He also says investors shouldn’t underestimate the power of market sentiment, especially at a time when technology and other sectors are facing headwinds. “If you look at home-building stocks, they’re the best direct play on the U.S. housing recovery, and everybody wants to play it,” Mr. Roibu says.
The magnitude of the stock gains has elicited heavy skepticism on Wall Street, where analysts typically are seen as cheerleaders for stocks.
Megan McGrath, executive director and home-building analyst at brokerage MKM Partners, this month downgraded Ryland Group, RYL -0.88% a major builder on the West Coast, to sell, and cut her ratings on D.R. Horton and Lennar to neutral.
“You can still be bullish on housing but not necessarily the home-builder stocks,” Ms. McGrath says. “We’re still in the early stages of recovery, but these stocks are up around 150% in a year, so we thought, look, if you’ve made the trade and you’ve made some money, maybe it’s time to take some profits.”
Susquehanna Financial Group analyst Jack Micenko believes shares have become too expensive. Mr. Micenko says that for shares to warrant their current valuations, the U.S. will need to build an average of 2.6 million new single-family homes a year from 2013 through 2016. During the peak of new-home construction in 2006, the U.S. built 1.6 million new single-family homes. He has a negative outlook on the group.
But today’s annual rate of 872,000 homes is still well short of the norm over the past half century. On average, builders have started construction on about 1.5 million new homes a year since 1959.
Mark Luschini, chief investment strategist with Janney Montgomery Scott LLC, argues that the current level of new-home sales is so low that there still is nowhere for home builders to go but up. “At the end of the day, homes are being sold at an appallingly low rate.…That still bodes well for home builders,” he said. The firm, which oversees $55 billion in its Parker/Hunter Asset Management arm, is keeping its position in the Dow Jones U.S. Home Construction Index steady.