Home builder stocks have been hit hard as the bond rout pushed at least one measure of mortgage rates past 7%. But there's a silver lining for the bold: builder valuations are showing a sign that typically precedes a period of outperformance, one analyst wrote Thursday.
"That's right," Evercore analysts Stephen Kim, Aatish Shah, and Randa Shaw wrote in a Thursday note, "the median small-cap homebuilder is now trading below 0.80x book value!"
In a week when little has gone right, the price-to-book value for small-cap builders is a ray of light for investors, according to Evercore's analysts. "Almost every time the median small-cap builder has breached this valuation threshold, the homebuilding stocks have outperformed over the following 3, 6, and 12 months," they write, adding that the only exceptions were a three-month period in 1990 and during the housing-led 2008-09 financial crisis.
Historically, Evercore's index of home-building stocks has returned a median 16% in the three months following the signal, 36% after six months, and 59% after a year, the note says. "While the valuation trigger is tripped by the small-caps, the outperformance applies to the whole sector," they added.
The signal comes with a couple of asterisks. Among them: the pool of public home builders has been shrinking, with Taylor Morrison, Beazer, M.D.C., and Tri Pointe Homes removed from the index following mergers and acquisitions in recent years. The analysts' small-cap index now includes Century Communities, Green Brick Partners, KB Home, LGI Homes, M/I Homes, and Meritage.
It could take patience for the signal to pay off. "The group doesn't always bottom on the day the small-caps hit 0.8x," the analysts wrote. "Many times, the actual trough occurs a bit later."
And the same signal blared in April, Kim notes-something that isn't unheard of. The small-cap index showed the same signal twice in 12 months in the mid-1990s, during the financial crisis, and in 2022. "Encouragingly, in both '97 and '22, the rise in the index after the second breach was quite significant," he wrote.
It's been a rough week in a tough month in a disappointing year for housing market watchers. Sales of previously owned homes dropped more than expected in August as mortgage rates headed closer to 7%, the National Association of Realtors reported on Thursday. The final two weeks of August, Opendoor CEO Kaz Nejatian wrote on X on Wednesday, "were among the worst we have seen for housing in years." Meanwhile, the 10-year Treasury yield, a barometer for mortgage rate movements, climbed as high as 4.976%, the highest since late October 2023, according to Dow Jones Market Data.
Meanwhile, this week's rise in yields pushed one measure of 30-year fixed mortgage rates, Mortgage News Daily's weekday survey of rates, above 7% for the first time in over a year. And as mortgage rates went up, home builders went down: the iShares U.S. Home Construction exchange-traded fund, which tracks the industry, closed at $88.22 Thursday, the lowest since May.
The fund was down 6.8% for the month through Thursday's close, according to Dow Jones Market Data.
Builders, along with the broader market, were headed higher on Friday. The iShares U.S. Home Construction exchange-traded fund was up 1.3% in midmorning trading, with the 10-year Treasury yield at 4.940%.