Solid earnings and indications of ongoing demand were not enough to buoy home builder stocks Thursday, which continued declines that started Wednesday.
SPDR S&P Homebuilders
ETF (ticker: XHB), which tracks builders and related industries, was down 0.9% at the close, while large builders like D.R. Horton (DHI), Lennar (LEN), and PulteGroup (PHM) were down 3.5%, 4.4% and 5.7%, respectively. On a weekly basis, the three builders are down 8.4%, 9.6%, and 10.7%, respectively.
Many of the sector’s stocks soared to new heights over the summer and early fall as the residential real estate market bounced back from a coronavirus-induced lull in early spring. With mortgage rates near historic lows, supply tight, and demographic trends in home builders’ favor, demand soared and builder confidence rose to new highs as orders surged.
The most recent data has shown more of the same.
beat third-quarter earnings expectations when it reported results Thursday morning. Single-family starts continued to increase in September, while the National Association of Realtors said existing-home sales in the same month increased by 20.9% year over year and 9.4% month over month.
The National Association of Homebuilders said builder confidence ascended to a new high in its October survey, while the average 30-year fixed-rate mortgage reached a brand new low this week, according to a Freddie Mac survey released this morning. The Mortgage Bankers Association, which releases weekly reports on the volume of applications for loans to purchase a home, most recently reported levels 26% higher than the same week a year ago.
So, what went wrong for builders?
The benchmark 10-year Treasury yield has been pushing steadily higher in recent weeks, and on Thursday afternoon was trading around 0.85%, its highest point since June. Mortgage rates generally track movements in the 10-year Treasury yield.
The 30-year Treasury yield has advanced to 1.66%, also its highest since June. That marks a contrast with near-term yields and short-term interest rates: The two-year yield has remained below 0.25% since April, after the Federal Reserve cut its policy rate to nearly zero.
Wall Street strategists cite a few reasons for the drive higher in long-term yields. The first is a brightening outlook for the U.S. economic recovery. Thursday’s better-than-expected jobless claims report gave a boost to 10- and 30-year yields, which both climbed four basis points (hundredths of a percentage point) on Thursday.
Second is expectations for stronger inflation in the future. Persistently stronger inflation erodes the value of long-term debt most, and inflation expectations are a key input into the levels of bond yields. Of course, the two of those—stronger economic growth and higher inflation—affect the long-term outlook for Fed policy, so higher bond yields could also be interpreted as investors betting on higher interest rates in coming decades.
The near-term outlook for Fed policy is affecting long-term bond yields as well. Central bank officials have said in recent speeches that they don’t expect to step up their pace of long-maturity Treasury purchases in the coming months. They have also said interest rates should remain near zero until the U.S. economy has fully recovered from the coronavirus pandemic. That means that the central bank is, in effect, lending less price support to long-term Treasuries than near-term Treasuries.
While an increase in the 10-year yield may make home builder investors jumpy, it’s unlikely to result in a sharp increase in mortgage rates for consumers, says Ivy Zelman, CEO of Zelman & Associates. The spread between rates and the 10-year Treasury yield is notably wide, so it’s more likely that mortgage originators will narrow the spread than raise rates significantly on consumers.
“Even though the 10-year yield is backing up, the actual rate to the consumer is not going to go up as much,” Zelman says. “As soon as things even marginally start to slow, the mortgage lenders will reduce their rates, because they need the capacity, they need the volume.”