Three ways to play Housing in a rate cut cycle

Existing home inventory is up…but few sales are starting to trade…will the floodgates open after rate cuts? … three options for real estate investment

Remember when there were no homes available for sale on the market?

Well, that’s not a thing anymore.

As you can see below, there are now 476,000 new homes for sale in the US. This is the highest level since 2008.

Source: Creative Planning / Charlie Bilello

So why are existing home sales still in the gutter?

You already know the reasons…

Record home prices (June marked the highest average sale price for a home ever) and mortgage rates that, while at an all-time high, are still multiples higher than they were three years ago.

Speaking of expensive house prices, here’s a pop quiz…

Ten years ago, the percentage of US homes priced over $1 million was less than 2%.

Where is that percentage today?

Ready?

8.5%… which we’ll call a 350% explosion.

Source: Charlie Bilello / Redfin

But with the Fed set to introduce its first rate cut since the pandemic in just a few weeks, what is the likely impact on housing and how might we benefit?

We’ll start by revisiting this rather colorful forecast from real estate entrepreneur and star of ABC’s “Shark Tank” Barbara Corcoran:

The moment interest rates come down, all hell will break loose and prices will go through the roof. (Right now, the sellers) are staying put. But they won’t stay put if interest rates drop by two points.

It will be a signal for everyone to go back and buy like crazy and house prices will (probably) go up by 20%. We could have COVID (the market) again.

While this “up 20%” forecast seems like a stretch, let’s look at some ways to take advantage of an uptick in home sales, starting with mortgage demand.

Although home prices remain near historic highs, mortgage rates have eased in recent months as the market anticipates interest rate cuts. This has already led to an increase in refinancing.

Behold Fox Business from last week:

The Mortgage Bankers Association (MBA) reported on Wednesday that applications for refinancing rose 35% last week as rates for the average 30-year and 15-year fixed-rate mortgages hit their lowest point in more than a year, according to Freddie Mac.

Increased demand for refinancing was the driving force behind the increase in total mortgage loan applications, which rose 15% for the week, the MBA said. In comparison, purchase orders increased by only 3%.

Year-on-year, the demand for refinancing increased by 118%, MBA data shows.

Now, if we’re already seeing that kind of growth, what happens to refinancing demand, say, six to eight months from now when the Fed has cut rates a few times? What about the mortgage origination application?

“Much higher” seems like a logical answer.

So how can we benefit from this?

Well, by putting a few dollars into some major mortgage companies.

If you’ve been with us for a while, you may remember Louis Navellier’s pick for InvestorPlace’s Best Stocks for 2020 contest

PennyMac Financial (PFSI).

Since then, Louis has made profits on PFSI as the housing/mortgage market has changed post-pandemic, but we can get an idea of ​​how Louis’ quantitative approach to the market would increase PFSI today using Portfolio grader instrument.

For newer Digest readers, fundamental strength, as evidenced by earnings superiority, underlies Louis’ entire market approach. Fortunately, Louis codified much of his quant based market system and now offers it to the investment community through his. Portfolio grader.

Think of it as a diagnostic that gives you a snapshot of a stock’s financial strength. It focuses on the same eight parameters that drive Louis’ stock selection process for all of its premium investment services.

Below, you can see how PennyMac gets a “B” rating today, making it an official “buy.”

By the way, PFSI doesn’t need lower rates to help its earnings. It’s already doing so well that they just increased their dividend.

For more, let’s jump to Chairman and CEO David Spector talking about PFSI’s Q2 earnings call from a few weeks ago:

PennyMac Financial delivered strong earnings in the second quarter with an annualized operating return on equity of 16%. Given our continued strong financial results, I am pleased to note that the PFSI Board of Directors has approved a common quarterly cash dividend of $0.30 per share from $0.20 per share, an increase of 50%.

Note that with lower interest rates, PFSI wins two ways: the prospect of increased refinancing volume, plus a new wave of new mortgage loan originations.

That’s likely part of the reason Spector concluded: “While our financial performance in recent periods has been strong, I continue to believe that Pennymac’s best days are still ahead.”

Lower rates would also be a tailwind for top home renovation companies

Think Home Depot and Lowe’s (full disclosure, I own Home Depot stock in my personal account).

Now, Home Depot gets a “D” rating according to Louis’ Portfolio Grader (and Lowe’s only gets a “C”). Three big reasons contribute to this: a lack of earnings momentum, weak sales and a lack of positive earnings surprises.

But this makes sense because it reflects the stifling interest rate policy of the past two years. When Home Depot reported earnings last week, management commented on those tough conditions.

From Executive Director Ted Decker:

During the quarter, higher interest rates and greater macroeconomic uncertainty put more pressure on consumer demand, leading to weaker spending on home improvement projects.

But the question becomes “what will happen to earnings momentum, sales and earnings surprises when the Fed starts cutting rates?”

Well, logic suggests that lower rates would unlock a wave of demand for new home projects. On that note, let’s go to MarketWatch:

(Home Depot) also indicated that there was less demand for larger home improvement projects that need financing as people wait for interest rates to drop to make them cheaper…

“Everybody expects rates to come down, so (they’re) putting projects off,” Decker said.

We think it’s only a matter of time before this pent-up demand turns into action…which turns into profit for home improvement companies.

To be clear, Home Depot didn’t ask for demand to explode this year. But for investors, there’s a balance between “waiting so long for evidence that we’re missing out on solid, early gains” and “moving so fast that we have to take more losses.”

From our perspective, if the Fed is indeed on the verge of another rate-cutting cycle, then getting into the position now — even if it’s a little early — is a wise move.

At the very least, if this track interests you, keep it on your radar as we head into fall.

Finally, what about homebuilder stocks?

Regular Digest readers know we’ve had this exchange for years at this point.

On April 20, 2022, DigestI suggested that aggressive investors might jump into an iShares Home Construction ETF (ITB) trade. ITB owns homebuilding heavyweights including DR Horton, Lennar, NVR, Pulte and Toll Brothers.

Here is our disclaimer from that Digest on our timing and the potential for additional volatility:

If you’re an aggressive trader who doesn’t mind being early and going through a sideways (or even down) move, this is a reasonable entry point.

Below, you can see the ITB drop further after April Digest as we warned, but then we rallied hard.

An aggressive trader who took this ITB position would be up 97% right now, nearly 4X beating the S&P’s 25% return over the same period.

Source: StockCharts.com

So what happens when the Fed starts cutting?

Well, with lower rates, these builders won’t have to offer the same incentives to offset the higher rates. That will increase their margins and add a tailwind for earnings.

On the other hand, builders may choose to maintain lower margins to keep prices lower than existing home prices to attract buyers.

Remember, as I mentioned at the top of today’s Digesthousing inventory is growing, but sales volume is still falling due to high prices. So if homebuilders are willing to undercut the prices of existing homes, what they give up in margins will be offset by higher sales volume – especially if Corcoran is right and home prices explode on the back of mass demand due to higher mortgage rates small.

So there you go. Three ways to play the broader housing market as we look forward to rate cuts.

We will keep you posted.

good evening

Jeff Remsburg