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June 25, 2019, 2:37 p.m. EDT

Homebuilder stocks get a downgrade, as housing market flashes warning signs

The quandary: Americans still need and are buying homes, but growth is flat

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By Andrea Riquier


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Which way is the housing market going?

Economic data is sending mixed signals. And now so are stocks.

Last week, analysts at Wedbush upgraded their home builder view, noting that with hearty consumer demand for housing, a supportive economy, low rates, and “reasonable” valuations, “investors should be willing to pay a higher multiple” for homebuilder stocks.

Not so fast, said a Raymond James analyst on Tuesday.

Read: Housing starts slip, but permits rise as all signs point to stronger growth ahead

“Ahead of next week’s earnings reports from Lennar /zigman2/quotes/202536373/composite LEN +1.08%   and KB Home /zigman2/quotes/206220859/composite KBH +0.94%  , we are highlighting our increased near-term caution with the homebuilding sector by preemptively lowering ratings on the aforementioned names,” Buck Horne wrote.

For the Wedbush analysts, the macro outlook was the most important thing, while Horne focused more on what he considers frothy prices. “Valuations are now trading above cyclical median multiples,” he said, even as fiscal 2019 earnings estimates have declined, on average, 9% since the start of the year.

/zigman2/quotes/202536373/composite LEN 61.71, +0.66, +1.08%
/zigman2/quotes/200043823/composite KB 36.18, -0.09, -0.25%

Shares of the two companies Horne downgraded on Tuesday show those lofty gains. Lennar shares have gained 35% since the start of the year, and KB Home stock is up 37%.

Read: Americans are driving until they qualify again, and builders are responding

But Horne’s views of the economy also diverge from those espoused by the Wedbush analysts. Horne cited the inversion in the yield curve, oil prices, sentiment surveys, and much more, to make a case that the economy may be slowing more sharply than expected. “Most relevant for our renewed caution, though, is that the homebuilding sector is no longer priced for a potential late-cycle shift, and if the yield curve is to be believed – there could be more cyclical risks ahead.”

For now, Horne acknowledges that local data “in key homebuilding markets are indicating a late-season boost in buyer traffic and home sales, most likely due to the drop in mortgage rates. That said, quick drops in mortgage rates often have an effect of pulling forward contracts from home buyers, which can leave an air-pocket of demand in subsequent months,” he said.

Related: Housing market sentiment hits a 5-year high: a good omen for sales?

What does that mean for stock investors?

“We are concerned that the Street may be picking up anecdotes around modest upticks in April/May new order growth thanks to lower mortgage rates – but is not focused enough on the extended and elevated promotions/ incentives needed this spring to boost absorption.”

Horne focused on Lennar and KB Home, due to report earnings on June 25 and 26, respectively. The FactSet consensus on Lennar is for a price target of $58.80, about 11% higher than Tuesday trading levels, with a buy rating. Analysts take a more cautious view of KB Home: a hold rating and a $26.36 price target, just pennies above current trading levels.

Lennar shares fell more than 1% and KB Home fell more than 2% on Tuesday. The sector /zigman2/quotes/202739297/composite XHB +0.35%  more broadly also traded lower.

See also: We’re probably at peak housing. Here’s what that means.

/zigman2/quotes/202536373/composite
US : U.S.: NYSE
$ 61.71
+0.66 +1.08%
Volume: 4.06M
Oct. 18, 2019 6:30p
P/E Ratio
10.21
Dividend Yield
0.26%
Market Cap
$19.60 billion
Rev. per Employee
$1.77M
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/zigman2/quotes/206220859/composite
US : U.S.: NYSE
$ 36.48
+0.34 +0.94%
Volume: 1.58M
Oct. 18, 2019 6:30p
P/E Ratio
14.49
Dividend Yield
0.99%
Market Cap
$3.22 billion
Rev. per Employee
$2.37M
loading...
/zigman2/quotes/202739297/composite
US : U.S.: NYSE Arca
$ 45.42
+0.16 +0.35%
Volume: 1.47M
Oct. 18, 2019 8:00p
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Andrea Riquier reports on housing and banking from MarketWatch's New York newsroom. Follow her on Twitter @ARiquier.

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