With Interest Rates Set To Drop, Are Homebuilder Stocks Like DR Horton And Pulte Group A Buy?

Our theme of Housing Stocks, which includes the stocks of home improvement players, building supply companies, and home builders has fared reasonably well this year, rising by about 11% year-to-date. This compares to the S&P 500, which has gained about 7% over the same period.  Despite somewhat mixed holiday quarter earnings from key home-building players such as DR Horton (NYSE:DHI) and  Pulte Group (NYSE:PHM) , investors appear optimistic about the theme as the interest rate environment in the U.S. looks set to soften. Earlier this week, Federal Reserve Chairman Jerome Powell indicated that the Central Bank does foresee lower benchmark interest rates during the year, while also noting that the U.S. economy was far from facing a recession. The possibility of lower mortgage rates is very positive for the housing market, as lower rates translate into better housing affordability and lower monthly mortgage payments.

Housing demand has outstripped supply post the pandemic. Moreover, high mortgage rates have meant that existing homeowners, who have locked-in mortgages at lower rates, are staying put in their homes, reducing the incentive to sell. This has led to a decrease in the market for both upsizing and downsizing homes, resulting in a shortage of existing homes for sale. Per the National Association of Realtors in January, existing home sales fell 1.7% from the previous year, with existing home sales prices rising 5.1% to $379,100, marking the seventh consecutive month of year-over-year price increases. This trend has proven advantageous for new home builders, as the overall housing market still faces a significant undersupply. New home sales rose 1.8% year-over-year to 661,000 units. Moreover, median sales prices for new homes have declined by about 2% to $420,700 as of December, as builders have lowered prices with inflation easing and this could also be stimulating demand.

DHI stock has seen extremely strong gains of 115% from levels of $70 in early January 2021 to around $150 now, vs. an increase of about 35% for the S&P 500 over this roughly 3-year period. Admirably, DHI stock has outperformed the broader market in each of the last 3 years. Returns for the stock were 57% in 2021, -18% in 2022, and 70% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Consumer Discretionary sector including AMZN, TSLA, and TM, and even for the megacap stars GOOG, MSFT, and AAPL. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could DHI see continued strength?