U.S. Stock Market: Concerns Grow as Homebuilder Trends Shift

Homebuilder stocks have seen a significant drop of around 30% after a prolonged period of growth. Is it the right time to invest? Likely not. The fundamentals started to weaken last year, as homebuilders continued to add to their large inventories despite a decline in sales. (Refer to the October 4 article, “Homebuilder Optimism May Be Ending As Conditions Weaken”)

The cycles of homebuilding

New home purchases usually follow long cycles. Currently, the trend is downward as the number of buyers decreases. This decline is likely due to more factors than just high mortgage rates. The prices of new homes are no longer increasing, which has diminished a crucial factor that previously attracted buyers. Coupled with today’s heightened uncertainties (see March 1 article, “Significant Uncertainties Put U.S. Stock Market At Risk”), the declining consumer sentiment is quite justifiable.

Notably, there are no significant positive developments expected soon, so homebuilders will need to focus on reducing their excess inventory. Historically, inventories have maintained around six months of sales levels. However, the optimism stemming from the unusually high sales in 2020-2021 led to a buildup of homebuilder inventories to approximately nine months based on the now-normal sales volume. Shrinking this 50% excess is quite a challenge. Moreover, as consumer sentiment continues to decline, the definition of “normal sales volume” could contract, further complicating efforts to reduce inventory.

Shifts in homebuilder stocks

Homebuilder stocks belong to the “consumer cyclical” sector, making them sensitive to economic fluctuations, financial conditions, and consumer sentiment.

While recent declines in homebuilder stocks may seem to have dampened investor optimism, the growing uncertainty risk is notable. This rising uncertainty may lead to further declines in new home sales. If such a downward trend materializes, expect homebuilder stocks to drop more significantly. The following graphs illustrate the recent declines, which, although substantial, have only reversed the last wave of optimism.

Stock performance charts of the four homebuilders in the S&P 500

First, the 15-month weekly chart displays the last optimistic surge and subsequent reversal. (Declines from 52-week highs: D.R. Horton -33%; Lennar -33%; NVR -26%; PulteGroup -28%)

Next, the 5-year monthly chart illustrates the prolonged increase followed by a recent partial reversal…

Conclusion: Homebuilder health intertwined with economic uncertainties

The four homebuilders listed in the S&P 500 represent a small segment of the index. However, many other sectors are interrelated with homebuilding and new homeownership. Thus, the health of homebuilders is a significant gauge of the economy’s overall condition and consumer attitudes. Consequently, the current downturn is yet another point of concern for investors.

As economic uncertainties escalate in both number and severity, as is the current scenario, pessimism takes hold and spreads. This growing pessimism channels investors’ focus towards uncertainties (or risks), further propagating and amplifying negative sentiments and outlooks. This vicious cycle is how bear markets emerge and gain momentum.

The critical question is whether we are approaching a bear market. The deteriorating health of homebuilders suggests an increasing likelihood of a slowdown. If the wave of uncertainties dissipates, conditions may improve. However, the nature, variety, and seriousness of these uncertainties indicate they will likely persist until visible results emerge, probably in the latter half of 2025.

Therefore, now is an opportune time to maintain cash reserves to seize future opportunities.