Homebuilder rally shows it's not just a 'Big Tech' market — a good sign for the economy

Homebuilder stocks have been on a tear — and rightly so, according to one analyst — which could be a good omen for the economy.

"More than anything, the rally in homebuilders shows the 2023 US equity rally is not just about Big Tech. Other pockets of the market are working as well," Nicholas Colas, co-founder of DataTrek Research, wrote in a note to clients on Tuesday.

The SPDR S&P Homebuilder ETF (XHB), which focuses on the US homebuilding industry, rose as much as 28.2% for the year, outperforming the S&P 500 Index's 12.7% gain, according to a research note from DataTrek. It also closed at a new 52-week high on Tuesday.

"Can a US recession really be just around the corner if homebuilding stocks just made a new high today?" he asked. "The short answer to the query posed above is 'no, obviously not.'"

Additionally, Colas noted, homebuilding stocks "remain cheap to the market."

For instance, the average valuation of the fund's top 10 holdings based on forward 12-month consensus EPS estimate is 14.6x, compared with the S&P 500 at 18.6x, Colas noted. That includes such homebuilders as PulteGroup (PHM) at 8.6x, Lennar (LEN) at 9.9x, D.R. Horton (DHI) at 12.2x, and NVR (NVR) at 15.6x.

One big reason for the optimism for homebuilders — and among them — is the limited housing supply, Colas wrote, especially in the resale market. Homeowners have been reluctant to sell their homes and swap their low rates on their current mortgages for ones that are twice as high.

As a result, buyers frustrated by the lack of choices among previously-owned homes are flocking to the new home market. In May, new home sales jumped 12.2% to a seasonally adjusted rate of 763,000 units from April, the government reported Tuesday. That was also up 20% from a year ago.

Builders have responded by accelerating their development plans. In May, a strong housing starts print showed new construction of both single and multi-family units jumped 21.7% to a seasonally adjusted annual rate of 1.631 million units.

Citigroup analysts led by Anthony Pettinari wrote in a note to clients on Monday that current shortages in housing “may provide a multi-year tailwind for builders.”

Builders foreshadowed this swing in fortunes in their latest earnings calls where they credited steady demand, tight resale inventory, and cooling price inflation on building materials for beating expectations and rosier outlooks.

Colas echoed all these advantages in his note, along with the slowing of interest-rate hikes from the Federal Reserve.

“And, if the Fed really is near the end of their current tightening cycle, then interest rates should decline in 2024 and beyond and support demand over the longer term,” Colas wrote.

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Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv

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