If you're shocked by the recent volatility in the homebuilder stocks, you're probably not alone. I've certainly been bullish on the sector for some time, although, of late, I've pulled back my horns. But if you take a step back from the daily grind of trading, you can see that the homebuilders are essentially a microcosm of what's happening to the U.S. economy, which is entering a decisive period.
The Bond Market Disagrees with the Fed
As I've noted many times, it's the reaction to the Fed's actions and post-meeting Powell talkfest that matters most. And the bond market's reaction rules the roost. Here's why it matters and what to watch next.
The Federal Reserve made it clear on 1/31/2024 that there won't be any rate cuts in March. Stocks stumbled. More importantly, bond yields crashed. If you haven't figured it out yet, bond traders are betting on a recession.
Bond Rally May Be a Sign of Trouble for the Economy
The U.S. Ten Year Note yield (TNX) responded to the Fed's actions and words by crashing below the 4% level, which had been support since January 11. Prior to that, bond yields climbed, as consumer prices and other inflationary measures reversed their recent decline. But as soon as the Fed made its intentions known, bond traders began to bet on a slowing economy.
As I write, TNX is testing the long-term support of the 3.8% area. A move below 3.8% would be extraordinary, as it would signal that bond traders are expecting a severe slowing in the U.S. economy.
Falling yields will eventually lead to lower mortgage rates. And while that is a welcome development, whether it spurs potential homebuyers off the sidelines remains to be seen. We'll know more in the next couple of weeks.
Why a Recession?
There are two emerging trends which may account for the bullish sentiment in bonds. One, as I noted here last week, is that homebuilders are reporting weaker sales and, in some cases, a rise in inventory. The other is that job losses are mounting.
According to the latest data from layoff tracking firm Challenger, Grey & Christmas, planned layoffs in the month of January totaled 82,307, a jump of 123% from December. So, despite the statistical gyrations and seasonal adjustments featured in the monthly payroll numbers from the U.S. government, the stream of layoffs continues to unfold. Recently, Citigroup (NYSE: C) announced 20,000 layoffs. United Parcel Services (NYSE: UPS) cut 12,000 jobs after its most recent earnings miss. And while these large company workforce reductions grab the headlines, you can view a more granular look at the layoff situation via the real time data offered by Warntracker.com. There, you can see that a wide variety of companies are slowly reducing the number of workers quietly. A few hundred here, twenty five there, and so on; it all adds up.
A more global number, confirming Challenger's data, can be found at Layoffstracker.com, which reports that, from January 2023 to the present, 1482 companies laid off a total of 496,509 employees. For context, according to this data set, the number of workers laid off in December 2023 and January 2024 combined was 53,205 – roughly 11 percent of all the layoffs in the past twelve months, which suggests the pace is picking up.
In addition, the number of jobless claims, reported this morning, rose by 12,000 in the most recent reporting week, 9,000 claims above expectation. California, New York, and Oregon led the way. Think tech and financial services.
Homebuilders: Where it All Comes Together
Food and shelter are the practical pillars of society, as they engender family and community formation. Yet, to fund both necessities, a person must have income. For a large majority, that income comes from a job. And with many jobs comes the benefit of a 401(k) plan. Banks and other lenders often factor in the value of a 401(k) plan in the final approval decision for loans, especially mortgages.
When a person loses a job, the 401(k) plan often becomes a source of income via borrowing or outright withdrawals. The source of funding for 401(k) plans is a combination of individual savings, employer contributions, and the trend of the stock market. A strong stock market, combined with a steady job, usually improves the value of 401(k) plans.
All of which means that, when a recession develops and job losses mount, the value of 401(k) plans becomes less predictable, and often falls. As a result, an individual's credit worthiness becomes less reliable. In the end, banks don't want to lend large sums of money to individuals with questionable credit.
What's most interesting is that the market's current bet seems to be that, even though homebuilders are struggling and job losses are mounting, the Fed will have to cave in as the economy stalls, and subsequently lower interest rates. In other words, if there aren't enough houses available, and interest rates fall far enough, somebody, somewhere will buy a house. That sounds plausible, except for the job thing, which, in the wake of the AI craze, is no longer as predictable as it once was.
Not All Homebuilders Are the Same
The homebuilder sector usually moves in tandem, usually based on the rise and fall of interest rates. Lately, however, there's been a great deal of variability in the price action of individual companies, as earnings and future guidance has made the difference between winners and losers.
This all-or-nothing response by traders is responsible for the sideways action in the SPDR S&P Homebuilder ETF (XHB), as the performance of individual stocks in the sector is reflective of earnings and future guidance. Some are falling, while others are holding up.
Last week, D.R. Horton (DHI) got clobbered after its earnings miss. The stock is showing signs of recovery, as lower bond yields offer long-term investors some comfort. Today's crash was Meritage (MTH), whose earnings were less palatable than Wall Street was hoping for.
On the other hand, other companies in the sector, such as Lennar (LEN), have avoided price volatility and are holding up better, as their guidance for future quarters has been seen by the market as acceptable.
From a money flow standpoint, note that the Accumulation/Distribution (ADI) and On Balance Volume (OBV) lines for XHB, DHI, LEN, and MTH are moving sideways, albeit with a bit of a downward bent. That's a sign that investors are taking a wait-and-see attitude about the sector as things develop.
Bottom Line
If you're looking for clues about the economy, look to the homebuilder stocks. Inside their earnings reports, you'll find information about the economy and how individuals' personal finances are faring. The most recent nuggets inside these reports suggest a softening economic environment.
The volatility in the sector, due to slowing sales and in some cases rising inventory, indicates that financial stress is rising in the pool of potential buyers due to inflation and job losses. Moreover, if job losses continue to climb, the odds are that homebuilders will eventually see even softer sales, especially in their newly targeted sector of starter homes. That's because, no matter how low home prices fall, or how many incentives are offered by homebuilders, if potential homebuyers don't have reliable income and adequate credit worthiness, the odds of a mortgage being approved are low.
There are increasing signs that the U.S. economy is slowing, which are more evident in the middle to lower income brackets. You can see it reflected in slowing home sales for starter homes. Yet, there is anecdotal evidence that those in higher income brackets are starting to feel the pinch of inflation. See the reference to UPS and Citigroup above, where executives made up a significant portion of the layoffs.
The Federal Reserve's tough talk about interest rates and the bond market's complete disagreement with the central bank suggests that the smart money is betting that the Fed will cave in and lower rates sooner rather than later.
I own shares in DHI and LEN.
Thanks to everyone for your support. I really appreciate it. This weekly report is available on my Buy Me a Coffee Page. If you like this report and want to receive early access this type of content on a regular basis, consider becoming a member. I also appreciate single coffees, which you can buy me here.
To subscribe to my premium service, Joe Duarte in the Money Options.com, click here. Please don't forget to hit the Like button on the posts. It helps to spread the word.
You're the music. I'm just the band.
To get the latest information on options trading, check out Options Trading for Dummies, now in its 4th Edition—Get Your Copy Now! Now also available in Audible audiobook format!
#1 New Release on Options Trading!
Joe Duarte
In The Money Options
Joe Duarte is a former money manager, an active trader, and a widely recognized independent stock market analyst since 1987. He is author of eight investment books, including the best-selling Trading Options for Dummies, rated a TOP Options Book for 2018 by Benzinga.com and now in its third edition, plus The Everything Investing in Your 20s and 30s Book and six other trading books.
The Everything Investing in Your 20s and 30s Book is available at Amazon and Barnes and Noble. It has also been recommended as a Washington Post Color of Money Book of the Month.
To receive Joe's exclusive stock, option and ETF recommendations, in your mailbox every week visit https://joeduarteinthemoneyoptions.com/secure/order_email.asp.
