U.S. Stock Market: Homebuilder Reversals Raise Concerns

After a lengthy rise, homebuilder stocks have dropped around 30%. Time to buy? Probably not. Fundamentals began weakening last year as homebuilders continued to build their significantly large inventories even as sales tapered off. (See Oct. 4 article, “Homebuilder Optimism May Be Ending As Conditions Weaken“)

The homebuilder cycles

New home buying tends to run in lengthy cycles. The current trend is now downwards as the number of buyers shrinks. Likely, the cause is more than a high mortgage rate. New home prices are no longer rising, thereby removing a key driver of buyer interest. Add in today’s high uncertainties (see Mar. 1 article, “Significant Uncertainties Put U.S. Stock Market At Risk“), and the weakening consumer sentiment is understandable.

Importantly, there are no significant positives on the horizon, so homebuilders will be working to reduce their excess inventories. Inventories historically have run at about six months of sales. However, the optimism built from the abnormally high 2020-2021 sales drove homebuilder inventories up to about nine months of the now back-to-normal sales volume. Reducing that 50% overage is a challenge. Moreover, with consumer sentiment weakening, “normal sales volume” could decline, making the race to reduce even more difficult.

Homebuilder stocks’ shift

Homebuilder stocks are in the “consumer cyclical” sector because they are sensitive to shifts in the economy, financial conditions and consumer attitudes.

While the recent homebuilder stock declines may appear to have reversed investors’ optimism, the uncertainty risk is growing. That uncertainty development means new home sales could fall further. If such a downtrend does emerge, expect homebuilder stocks to drop significantly. These graphs show the recent drops that, while large, have only erased the last optimistic surge.

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

First, the 15-month weekly pattern shows the final optimistic run-up and reversal. (Declines from 52-week high: D.R. Horton -33%; Lennar -33%; NVR -26%; PulteGroup -28%)

Second, the 5-year monthly pattern shows the extended rise and recent, partial reversal…

The bottom line: Homebuilder health is tied to economic uncertainties

The four homebuilders in the S&P 500 are a small component of the index. However, many other industries are linked to homebuilding and new home ownership. As a result, homebuilder health is an important indicator of the economy’s condition and consumers’ sentiment. Therefore, the current weakening is one more concern for investors to consider.

When economic uncertainties grow in number and seriousness, as is happening now, pessimism emerges and expands. That growing pessimism narrows investors’ focus to the uncertainties (AKA, risks), thereby spreading and strengthening pessimistic attitudes and outlooks. This vicious cycle is how bear markets form and pick up speed.

So… The question is whether a bear market is close. Weakening homebuilder health indicates the probability of a slowdown is growing. If the flood of uncertainties evaporate, conditions could improve. However, the number, type and seriousness of the uncertainties likely means they will be around until the results become visible, likely in the second half of 2025.

Therefore, now is a good time to hold cash reserves to take advantage of opportunities in the future.