May 13, 2018 / 5:04 PM / a year ago

RPT-Wall St Week Ahead-Homebuilders poised for gains but face interest-rate fears

    By April Joyner
    NEW YORK, May 11 (Reuters) - Some investors are betting on
shares of homebuilders to outperform U.S. stocks at large, but
with interest rates expected to rise they may have to wait
several months before those bets pay off.
    The U.S. economy looks ideal for homebuilding stocks to
benefit. The unemployment rate has fallen to its lowest level in
more than 17 years              and consumer confidence is near
the highest levels in 17 years, according to the Conference
    And demand for housing in an already tight market is being
supported by the many millennials seeking to purchase their
first home, several investors said.
    The U.S. Commerce Department's data on April housing starts
will be released on Wednesday, followed by data on new-home
sales on May 23.
    But other factors could raise costs for home buyers,
potentially hampering home sales. A sharp rise this year in U.S.
Treasury yields reflects increasing worries about inflation and
fears that the Federal Reserve will raise interest rates more
aggressively than has been expected. 
    The yield on the 10-year Treasury note is used as the
benchmark for mortgage interest rates; higher rates increase
mortgage costs for home buyers.
    "The continued rally in yields is a potential red flag,"
said Jared Woodard, an investment strategist at Bank of America
Merrill Lynch in New York.
    The 10-year Treasury yield             has briefly exceeded
the 3 percent mark, the highest level since January 2014 and
more than 50 basis points higher than where it started the year.
    The S&P Composite 1500 Homebuilding index              has
lagged the broader market, falling 16.9 percent from its Jan. 22
peak, which is more than three times the percentage decline of
the S&P 500        from its high that month. In 2017, the
homebuilding index soared 74.8 percent from the previous year.
    Other factors also cast a cloud on the housing market. Last
year's federal tax overhaul put a cap on deductions for state
and local and property taxes and lowered the amount of mortgage
interest that is deductible, all of which results in higher
costs for many homeowners.
    Homebuilders have also pointed to rising costs for materials
and labor in their earnings calls, though so far they have had
little impact on their margins.
    "The factors indicate that there may be some headwinds going
forward," said Michael Cuggino, president and portfolio manager
of Permanent Portfolio Funds in San Francisco, which owns shares
of Lennar Corp        , the largest U.S. homebuilder by market
    Shares of the five largest U.S. homebuilders by market
capitalization jumped on April 4, when Lennar reported robust
quarterly sales and raised its forecast for the year. Lennar's
shares climbed 10 percent that day, and PulteGroup Inc        ,
D.R. Horton Inc        , Toll Brothers Inc         and NVR Inc
        rose between 4.1 percent and 6.4 percent.
    The stocks have given up much of those gains since then,
even though homebuilders have continued to deliver upbeat
results. Lennar shares have tumbled 13.7 percent. D.R. Horton,
NVR and Toll Brothers are down 3.9 percent, 3.3 percent and 3
percent, respectively. Only PulteGroup has added to its April 4
gains, rising 1.8 percent.
    Homebuilders that sell units at multiple price points, from
starter homes to luxury properties, and are active throughout
the United States are best positioned to withstand investors'
skittishness over interest rates, Cuggino said.
    Next up to report is Toll Brothers, which focuses on the
luxury market and is scheduled to release its quarterly earnings
on May 22.
    Still, some investors say this year's industry
underperformance looks like a normal response to the 2017
    Though housing starts have risen, hitting 1.319 million
units in March, demand among home buyers has outpaced the
limited housing supply              in part because of the many
millennials are entering the market.
    "This is just a pause," said Brian Macauley, co-portfolio
manager of the Hennessy Focus Fund in Arlington, Virginia, which
owns shares of NVR. "As fundamentals come through, the stocks
will behave better."
    Signs of worries about affordability among home buyers, such
as a move toward smaller homes or an uptick in adjustable-rate
mortgages, have not yet emerged, said Jack Micenko, an analyst
at Susquehanna Financial Group in New York.
    Low earnings multiples could also draw investors' attention.
The 12-month forward price-to-earnings ratio for the S&P 500
Homebuilding index             , which comprises just Lennar,
PulteGroup and D.R. Horton, has fallen to 9.5 from 13.7 at the
end of 2017. The price-to-earnings ratio for the S&P 500 is 16,
down from 18.5 at the end of 2017.
    "If (homebuilders) have solid orders and growth and hold
their margins, they could work from here," said Jonathan
Woloshin, head of Americas equities and real estate at the chief
investment office of UBS Global Wealth Management in New York.
"There are some very attractive valuations out there."

 (Reporting by April Joyner
Editing by Alden Bentley and Leslie Adler)
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