Throughout 2018, the housing market in the U.S. was in a downward trend in terms of housing starts and new home sales. Those two industry measures go hand in hand, and both trended lower in 2018 as the Federal Reserve was in a rate-hiking cycle. The housing industry is very sensitive to interest rates. The Fed made a 0.25% hike in December, but since then they have changed their tone to a more dovish stance. The Fed has held rates steady over the last few meetings and it hasn’t expressed an interest in raising or lowering rates at this time.
This change in stance from the Fed could have been the good news the housing industry needed. So far in 2019, housing starts and new home sales have been trending higher. The housing starts report for April was released on Thursday, and it showed an increase of 5.7% on a month over month basis. The seasonally adjusted annual rate for housing starts was at 1.235 million. The other part of the report is building permits, and those increased by 0.6% in April and the annual pace came in at 1.296 million. This is the first monthly increase since December.
New home sales will be released on May 23, and I am hopeful that the trend will continue to move higher. You can see on the chart below that new home sales peaked in November 2017 and then trended lower throughout 2018. The readings seemed to hit bottom in October 2018 and have been trending higher since. The March reading was the highest reading since the peak mentioned earlier.
From an investment standpoint, the SPDR S&P Homebuilders ETF (NYSE: XHB) is a strong gauge for the housing industry. The list of holdings in the fund includes homebuilders like D. R. Horton, Pulte Homes, and Lennar. It also includes home improvement retailers Home Depot and Lowe’s. There are also building products manufacturers like Fortune Brands and Owens-Corning.
If we look at a chart of the XHB, we see that the ETF peaked in January 2018 and then trended lower throughout the year before finally bottoming in December. Like the overall market, the XHB rallied sharply in the first few months of 2019. The rally stalled a little in February and March, but it then resumed. From the low in December to the recent high, the ETF rallied 36.4%.
Because of the way I analyze stocks, I went into Investor’s Business Daily and looked at the fundamental ratings for the top 10 holdings of the XHB. I looked at IBD’s EPS ratings and SMR ratings as a quick reference to see how the fundamentals of the holdings stacked up against other stocks. The EPS rating measures a company’s earnings growth over the last few years and the last few quarters and the scores range from 1 through 99. The SMR rating measures a company’s sales growth, profit margin, and return on equity. These ratings range from A to E with A being the best and E being the worst.
I took the findings and put them into the following table. I calculated the average for the EPS rating and I used a traditional 4-point grading scales to come up with an average for the SMR ratings as well. What we see is that the average EPS rating for the top 10 holdings in the XHB is 84.8 and the average grade for the SMR ratings is 3.2, or a B+.
These figures are really strong for averages. You would be hard pressed to find an industry where the averages of 10 stocks would score better than what we see here. What this tells me is that the homebuilding industry does appear to have turned the corner and looks to continue the growth trend that started at the end of 2018.