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Don’t bet the house on homebuilders – BCA Research

There are growing risks that the consolidation phase in homebuilding stocks may give way to a downleg, unless housing starts are able to accelerate fast enough to justify premium valuations, according to BCA Research.

The relative price/sales ratio for S&P homebuilding is currently 180% above its long-term average, which itself is skewed higher because of last decade’s housing bubble.

Homebuilding sales would need to advance by 125% just to bring the price/sales ratio back to ‘normal’, all other things equal. Regression analysis suggests that housing starts of 1.5M are required for homebuilding revenue to grow by 125%. That compares with current housing starts of 850K, implying growth of 67%.

Such an aggressive growth rate is in line with historic norms during housing recoveries, but time horizons vary. In the current cycle, premium valuations put significant pressure on builders to push out product quickly. Note that housing starts and the unemployment rate have a close inverse correlation. Using regression analysis, the unemployment rate would have to fall to 5.7% to be consistent with housing starts of 1.5M.

To reach that goal, the labor market recovery will have to exceed the Fed’s current forecasts by a wide margin. That is an ambitious target, and the longer it takes, the more investor patience with rich valuations will wear thin.

Our US Equity Strategy service remains neutral on the S&P homebuilding index, but has it on downgrade alert and will cut positions if employment conditions deteriorate.

This post was originally published by the BCA Research blog.

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