As "For Sale" signs crop up in neighborhoods across America this spring, along with the daffodils and tulips, housing starts are also going gangbusters. Digging deep into the historical data, it turns out that housing starts are an important economic indicator that offer clues to the health of the overall economy.
Drilling down to related stock market sectors, healthy consumer confidence levels, a strong labor market and still ultra-low mortgage rates increase investor attention on homebuilder stocks, especially with the traditional spring housing market set to kick into high gear, analysts say.
Recent data revealed housing starts were up 5.2% in February and registered a year-over-year increase of 31%. Housing starts may be a good indicator of economic growth, not because of the importance of construction to the U.S. economy, but because of its reflection of consumer confidence, says Sam Stovall, managing director at S&P Global Market Intelligence. "Consumers are not going to buy a home if they feel uncertain about the outlook for the economy," Stovall says.
A Recession Indicator?
After recession fears flared-up earlier this year, investors may find some comfort in this correlation: Housing starts have been a significant warning sign for impending recessions in the U.S. over the past 55 years.
"Since 1959, seven of eight recessions were accompanied or preceded by year over-year declines in housing starts of 30% or more," Stovall says. The good news is for now, the housing starts data suggests the U.S. economy is not on the verge of a renewed economic contraction. See figure 1 below.
Stocks For A Watch List
If homebuilder stocks haven't been on your radar screen, some traders may be considering adding them to a watch list. "Interest rates are staying low for the foreseeable future. We are seeing decent employment numbers. Housing and employment are related. When people have more confidence they tend to buy bigger ticket items like houses and durable goods," says JJ Kinahan, Chief Strategist at TD Ameritrade.
A Fed Boost
The Federal Reserve may have also given an extra boost of fertilizer and spring rains to the homebuilders sector this year. "Homebuilders are usually pressured by a rising rate environment. But, now the Fed has stated they will raise rates only twice this year instead of four times," Stovall says.
Another reason investors might want to take a second look at homebuilders are valuations. "We find valuations or P/E ratios pretty attractive for homebuilders compared to the overall market," Stovall says. He pointed to homebuilders P/E ratio at 12.2, based on 2016 estimates versus 17.2 for the S&P 500.
The homebuilding trend offers investors the opportunity to expand a view too. "While homebuilders are interesting, there are a lot of related businesses that can benefit from a stronger housing market including companies like insulation makers, appliance makers, companies that make drywall and even home improvement stores," says Kinahan.
"If you are a believer that rates will stay low through the spring and summer and that the jobs market will remain strong, this is a sector that you might consider looking at," Kinahan says.
TD Ameritrade clients can explore homebuilders via a heat map in the thinkorswim® platform. See figure 2 below. The size of the square indicates the market cap of that name. The larger the square, the bigger the market capitalization of that company.