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Gradually Higher Rates May Not Be Roadblock for Housing Sector

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November 10, 2015
Looking ahead at the strength of the home building stock sector.

Low interest rates and an improving labor market have fueled steady improvement in the U.S. housing sector throughout 2015, government data shows. Could higher rates from the Federal Reserve throw a wrench into the housing recovery and trickle down to housing-related stocks?

For now, most housing industry analysts don't appear to be sweating the move toward higher rates. They say the building blocks remain in place for continued strength in the housing sector.

"Look at the blow-out employment report we saw last week. Nothing helps the housing market like new job creation," says JJ Kinahan, chief market strategist at TD Ameritrade. October non-farm payrolls surged 271,000 in October, far beyond Wall Street’s consensus estimate. Analysts quickly upped the odds of a December rate hike following last week's news; Fed funds futures markets are pricing in a better than 70% chance for a rate hike next month.

As investors scan the stock market landscape with the specter of higher rates on the horizon, the housing market and home-related stocks may have a buffer zone, say industry analysts.

"People still want to live in nice homes and still want to raise their kids in a good school system. Even if we see a full point increase on a 30-year mortgage over the next year, that is a muted amount per payment over the life of the loan," Kinahan said.

Home-Related Stocks Have Outperformed

Home-related stocks have been strong performers—outrunning the broader stock market—so far in 2015. Through November 6, the S&P 500 home furnishings index is up 19.8%, the home improvement retail index is up 14.8%, and the homebuilder's index is up 4.8%, according to S&P Capital IQ. That compares to a 2% gain in the S&P 500 (SPX).

Previous periods of Federal Reserve rate hikes have resulted in both positive and negative results for home-related stocks. In 1994, the Fed raised interest rates seven times in 12 months, pushing the Federal Funds rate to 6% from 3% in the calendar year. The S&P 500 homebuilding index fell 35.5% versus the SPX’s 1.5% drop in that stretch, notes Sam Stovall, managing director at S&P Capital IQ.

"That said, it doesn't mean future Fed rate increases will result in the homebuilding index getting hammered," Stovall says.

There’s some history to support that notion, too. During the Fed's two-year hiking program from 2004–05, the S&P 500 homebuilding index rose 33% and 26%, respectively, versus SPX increases of 9% and 3%, Stovall said.

There were important economic variations between the 1994 and 2004–05 Fed rate hike campaigns. "The key differences are the underlying strength of consumer confidence, combined with the aggressiveness of the Fed rate increases," Stovall explains.

And Now?

How do the factors mix up for this expected Fed rate hike cycle?

"Our belief is that the Fed will be taking a measured and well-telegraphed rate-tightening path. Consumers will likely not be scared off from purchasing new houses, and investors will likely not be deterred from purchasing or holding onto shares of home-building stocks," Stovall says.

An optimistic outlook remains in place for the housing market ahead. "If people are getting hired, that is the first step. The second step is wage growth. We did see some wage growth and that could continue to improve as firms have to compete for talent. Both of those factors will continue to drive the housing market," said Kinahan.

Data for housing construction starts has proved to be an accurate warning signal for economic activity and recessions ahead. "Since 1955 every recession but one has been preceded by a 30% decline in housing starts," said Stovall. He pointed to the 18% year-over-year increase in U.S. housing starts through September as a "very strong sign" for the economy ahead.

Investors looking to play the ongoing housing market ups and downs can consider a variety of stock sectors including financial services, home builders, home furnishings, and household product makers, as well as improvement store retailers.

"Even if people are pulling back on buying new homes, that means they could spend more at home improvement stores to fix up their current homes," Kinahan says.

TD Ameritrade clients can use the Company Profile tool on tdameritrade.com to dig deeper into this industry (figure 1).

Company profile tool on tdameritrade.com

FIGURE 1: BEFORE YOU MOVE. Navigating stockpicking should start with careful research. Log in to tdameritrade.com > Research & Ideas > Stocks > Enter Ticker > Company Profile. You can drill down on fundamental drivers, news, charts, social signals, and more. Company profile of Toll Brothers (TOL) is not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

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