The home builder sector will underperform in 2018

The home builder sector has outperformed the S&P 500 since December 18, when the NAHB Housing Market Index reported a surge in confidence in the housing industry.
Here’s XHB (home builder ETF).

Here’s the S&P 500.

Here’s the NAHB Housing Market Index. Notice how this Index is near all-time highs.

What history tells us

There were only 3 similar cases in which home builder optimism was this high. 1993, 1998, and 2005.
The home builder sector struggled over the next year in each of these historical cases. Red = the major home builders. Green = suppliers.

Housing starts struggled over the next 2+ years when builder optimism was this high (historically).

It’s important to note that the NAHB’s data does not go far back enough into history. Hence, you should not be overly concerned about this excessive optimism.

My thoughts on the home builder sector and U.S. housing in 2018

XHB (home builder ETF) massively outperformed the S&P 500 in 2017: 31% vs 20%.
I think the home builder sector will underperform the S&P 500 in 2018.
Optimism among home builders is indeed excessively high. And although I don’t expect Housing Starts to fall in 2018 (as they did after 1993, 1998, and 2005), I do expect New Home Sales and Housing Starts growth to slow down in 2018.
Here’s New Home Sales. This economic indicator shows no signs of deterioration.

Here’s Housing Starts. This economic indicator shows no signs of deterioration. Notice that Housing Starts is historically low. This suggests that Housing Starts still has a lot more room to grow over the next few years.

The Republican’s tax bill lowers the mortgage interest rate deduction from $1 million to $750k. This will hurt high-end real estate sales. Since the majority of housing growth comes from lower-end sales (e.g. for young families), the tax bill will dampen the housing market’s growth rate.

4 comments add yours

  1. Hi Troy, Interesting data. I have often looked at investing in the supplier side (HD and Loews) but never pulled the trigger. The builder side has always seemed pretty cyclical to me so I have avoided it. It will be interesting to see what happens from the new tax code and the true impact it will have over the next couple years. Tom

    • Yes, the builder side is very cyclical. Moves in tandem with the u.s. Housing market

  2. I too, agree with your analysis. Never invested in them myself due to the cyclical nature of the builders as well as the raw materials (lumber, etc.). I do like their land inventory though. I do own HD which is insulated to a degree – typically when housing starts fall, remodels increase. Another way I invest in the space is through title insurance (FAF for one). With the tax bill I suspect an uptick here due to downsizing, investor purchases, etc. I really love businesses that profit on transactions.

    • I’m surprised that New Home Sales and Housing Starts are so low, given we’re in the late stages of this economic expansion. But I guess that’s because housing was extremely depressed by the last recession.

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