Homebuilders Will Sell With Rising Interest Rates And Slower Sales | Seeking Alpha
Long end interest rates are rising, affecting mortgages and costs.Lenders are starting to contract from delinquent loans.Homebuilders have already been behind the curve with sales; these factors will
Long end interest rates are rising, affecting mortgages and costs.
Lenders are starting to contract from delinquent loans.
Homebuilders have already been behind the curve with sales; these factors will make it more difficult.
I got into a small debate over the weekend regarding home sales throughout the country. There are a few things going on with the housing industry and the following charts will show this. First, mortgage rates have declined. But, refinance and purchases have also declined. While the decline in the mortgage rate was modest, there may be outlying factors that are affecting housing. I am beginning to believe that the housing industry, despite obvious opportunities, is slowing down.
Mortgage Rates Lower & Interest Rates Lower:
Mortgage rates are now 4.17% for last week. This rate has been declining slightly as the economic outlook shows signs of slowing in the United States. As the chart below shows, mortgage rates are increasing, having moved from historic lows of 3.47% up to the more levels as high as 4.35%, but more recently to the 4.17%.
The big thing to think about when you consider mortgage rates is the relationship of rate increases to purchasing power. A 1% increase in mortgage rates equates to an 11% decrease in purchasing power of a home. This is not linear. This 1%:11% ratio is a tendency and the chart shows this:
If purchases decline when mortgage rates go upward, shouldn’t there be a requisite move upward in purchases if there is a move downward in mortgage rates? Yes, if the relationship is linear. Economics is never linear.
Given the ratio of increases in interest rates and declines in purchases, the recent declines in the mortgage rate has coincided with decreases in both purchases of homes, new and existing, as well as decreases in refinancing of mortgages. New homes and existing homes have both declined month-over-month, albeit modestly. Both of these indicators may have topped out for now:
These two charts show the past five years’ worth of purchase activity. Both have been tapering off as of late. But, the latest mortgage rates have been declining. There should have been moves upward in either refinancing or purchases. Both of these have dropped.
The debate I got into over the past weekend focused on how sometimes individuals fail to see what is going on in the market and believe that an economy will continue to perpetuate. The 2008 financial crisis is a perfect example of this.
The Fed to Push the Yield Curve
I am a firm believer that we are going to see the long end of the curve go higher with the Fed shrinking the balance sheet. Debt from the United States Federal government is about to expire and the Fed will not be rolling over these debt instruments. With the shortage of demand on the long end, price will have to drop as a new equilibrium price is established. This will push the long end upward in step with the short end increases the Fed is undertaking. Because of that, the long end of the yield curve will mean higher mortgage rates, which will pull down purchases, given the relationship of higher interest rates and lower purchases.
The Fed does not change reserve requirements too often for two reasons. First, the effects on normal operations for banks would have a more volatile effect. The second reason it is a far more precise policy targeting tool by purchasing assets in the open market system. By purchasing these assets, effectively the Fed transfers bank reserves to its own balance sheet, allowing banks to use the new liquidity to loan out these funds, thereby stimulating the economy.
However, the Fed is now going in reverse. The Fed is allowing these longer-term assets to expire without rolling over the funds into new bond holdings. This eliminates a bidder. Price will fall on the longer term debt instruments of the United States government. Mortgage rates will follow this trend.
Higher Delinquencies and Tighter Credit
The Capital One Financial Corporation (NYSE: COF) miss is a perfect example of what is going on in the economy. Capital One missed its latest earnings by some 22%. The company has to set aside money for loan losses as well as writing down loans. Delinquency rates are moving upwards again. This is resulting in lenders tightening credit and will restrict future credit.
Incomes are not increasing. While there have been some strong expenditures going into the end of 2016, these expenditures came from credit. Now, those loans are coming due and individuals are missing their payments on these loans. Expenditures are going to contract if individuals are strapped with payments.
If the relationships from the above charts continue, then refinancing of mortgages will drop. As for purchases, it may be that there are some “fence-post-sitters” that are finally motivated to make a purchase. However, this is predicated on a linear economy. I do not believe this economy is linear, but instead beginning to slow down.
Lenders are starting to reel from rising delinquency rates for credit cards, autos and mortgages. These lenders are going to have to set aside assets for loan loss provisions. We have already seen Capital One miss its earnings and I believe that more will be reporting missed earnings over the next quarter. Capital One is distinctive because of its focus on credit cards versus other financial companies that are diversified in other aspects of finance.
Delinquencies are just starting their move upward after a surge in borrowing from the final quarter of 2016. Credit cards are usually the first to see a rising delinquency rate followed by autos and then homes. Capital One is giving us a first look at how the economy is transforming. But, it is the homebuilders that I am beginning to doubt. These firms have not been able to incentivize purchasers to come into the market at lower rates on a high level. With the higher end of the yield curve moving higher from the Fed’s interest rate changes, along with the relationship from higher interest rates and costs for purchases, the homebuilders are going to have a tough time. Plus, I see further restrictions on lending because of delinquency rises and loan loss provisions.
This is all spelling out a slowing housing future. You have the increase in the yield curve which is going to eventually drive up interest rates. Also, lenders are starting to tighten credit because of previously mentioned loan losses. Incomes are increasing at a slower rate. These variables are starting to work their way into the housing market; the decrease in the mortgage rate should have driven up purchases of new and existing homes. But, that is not the case.
The Homebuilders will suffer
I expect more of this to happen. I expect the housing sector to start to slow down and housing ETFs to taper off. I am going to be watching the weekly mortgage application rates diligently for continued signs of a housing slowdown.
I am looking at the iShares U.S. Home Construction ETF (NYSEARCA:ITB) – Barchart – versus the three leading homebuilders in America, D. R. Horton (NYSE: DHI) – Red line, PulteGroup (NYSE: PHM) – Orange Line, and Lennar Group (NYSE: LEN) (LEN.B) – Yellow line. I took a good hard look at the projected revenues and the associated chart.
The chart is a weekly chart going back to last summer. I wanted this chart to show this timeframe specifically for one reason: In the last quarter of 2016, there was a surge in credit extensions to borrowers for credit cards, autos and home loans. You can see the rise in the charts listed above from both new home sales and existing home sales.
As the chart shows, home sales have been growing since the end of the Great Recession. However, as the chart also shows, new home sales have fallen well short of keeping up with existing home sales. The two data indicators typically move in lock-step.
We are now entering a period where several events are colliding:
- The Federal Reserve is shrinking its balance sheet which will push long-term interest rates higher. The effects on higher interest rates were explained above.
- Creditors have over lent and now delinquency rates are increasing. This will force lenders to contract lending which will lower home sales in the United States.
- Personal Income growth has been slowing. Without growth rates in incomes increasing, how will consumer expenditures increase? The two go hand-in-hand and therefore a slowing income growth rate equates to a slowing consumption rate. Home sales will see a decreasing rate of sales from this.
There are several factors that are going to affect the housing market. Homebuilders have not kept up with the demand for housing in the United States already; and yet, I am seeing projects for future growth of earnings from the three listed companies all pointing higher. Where does that growth come from?
The projected earnings for each of the equities is as follows:
Horton beat earnings expectations for the second quarter of 2017 by posting a $0.60 earnings per share versus $0.59, an increase of just $0.01. Keep in mind for all of three of these companies, there was a surge in credit.
during the last part of 2016 when these sales would have occurred. Now, there is a tightening of credit along with higher interest rates. Sales are moving lower as we have seen in the past month’s data.
Lennar is no better:
Lennar beat expectations by $0.01 as well. This same period of time was during the surge. Again, the lenders are starting to contract lending. The projected growth rates are not going to come true. With declining lending, I do not see how the profitability hits its targets.
Finally, Pulte Homes beat
expectations by $0.01 also. And, again the period of reporting was during a surge in lending; and again, going forward there is no room for upside with lenders contracting and interest rates heading higher.
Mortgage Applications Decline:
The real tell-tale is that mortgage applications are declining. Here is the latest chart on a month-over-month basis:
If you factor this out, starting 12 weeks ago, you would think that this data would be doing well. It is not. After 12 weeks, the mortgage application rate is only up 3.1% in total.
Do not be fooled, however. This increase is due to sales in existing homes as well as refinancing mortgages, not from new home purchases – the data on that is still coming in. My best guess is that the data is going to be lower for new home sales, just as the chart above shows for existing home sales and new home sales.
There are a lot of expectations for increases in housing. I do not see that coming true. There are too many variables affecting the purchases of new homes. New home sales have lagged significantly from existing home sales, so while the housing market may be robust this is not going to help the homebuilders. The declining housing market is going to hit the major builders first. More and more data is coming in that will support this.
I expect a move lower in the housing market as this continuing data hits the wire. I am expecting moves of around 10-15% lower in these stocks.
I am becoming heavily bearish on housing and homebuilders. Interestingly, the market did not pay attention once before. That was in 2008.
Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
On – 08 Jun, 2017 By D. H. Taylor