Have Homebuilder Stocks Bounced Too Far?

Looking at homebuilder stocks, you would think the good times are back. Since the lows of last year, they’ve rallied hard in anticipation of a big rebound in sales to home buyers. The data don’t yet justify the rapid rise in homebuilder stocks, as the November data for the Standard & Poor’s/Case-Shiller home-price index shows that home prices have fallen for the third straight month in a row. Except for a move up in April 2011, home prices have had 18 months of decline.

Considering record low interest rates, there doesn’t seem to be any rush by home buyers to step in aggressively to buy homes. This is a troubling sign. Interest rates can’t get any lower, but evidently home prices can continue to drop. Why aren’t home buyers scooping up the deals? While it’s great that home prices and interest rates are both low, you need several things to drive home buyers. Home buyers need security in their jobs, which means more job growth and visibility in their current jobs, plus the excess inventory of foreclosed homes needs to be cleared.

This could take several years, as some analysts don’t expect home prices to rise significantly until 2015. The problem at that point is that interest rates will most likely start rising. The current level and length of time that interest rates have been this low is unprecedented. U.S. interest rates can’t remain at these levels forever. The Federal Reserve indicated that it expects low interest rates until 2014, at which time hikes will be coming. That certainly won’t help home buyers when they need to get a mortgage.

Now that we’ve briefly touched on the fundamentals of the housing market, let’s take a look at homebuilder stocks. After making lows in the fall, all of the homebuilder stocks have had a massive run up in just a few months. Toll Brothers, Inc. (NYSE/TOL) has risen from $13.16 to $22.41 currently, a 70% move. D.R. Horton, Inc. (NYSE/DHI) has risen from $8.03 to the current price of $14.18, a move of approximately 77%. Lennar Corporation (NYSE/LEN) has moved up from $12.14 to $22.40 currently, a return of 85%.

Many investors are trying to call the bottom in housing by buying homebuilder stocks before home prices have actually started moving up. Home prices need to start moving up for homebuilder stocks to dramatically increase sales and profit margin levels. While it may seem smart to get ahead of the crowd, you must be careful not to buy a value trap, which is a stock that seems cheap, but then can stay cheap for a long period of time.

I would want to see home prices start moving up for several months before jumping in all the way with homebuilder stocks. But we’re not seeing massive job growth and, with interest rates this low, there still isn’t a ton of home buyers stepping in to scoop up the existing real estate that’s cheap. It could be a long time before homebuilder stocks start generating massive returns to justify the big moves. I think that’s highly unlikely that these homebuilder stocks will move up 70% or more from current levels over the next few months. At this point, investors need to see the earnings justify the moves we’ve just had and, with home prices continuing to fall, that’s going to be difficult.