The benchmark S&P 500 Index notched a new all-time high last week, but one industry that tends to lead rallies has been conspicuously absent: Housing stocks.
Could lagging homebuilders be an early warning sign of trouble ahead for the stock market?
As you can see in the chart below, the Philadelphia Stock Exchange Housing Sector Index (HGX) has been struggling all year and is forming what looks suspiciously like a head-and-shoulders top. That’s a classic technical-analysis pattern that often results in major trend reversals to the downside.
If the index drops past 173, housing stocks could swiftly decline another 20 percent. What’s interesting — and frightening — is the fact that up until a few months ago, housing stocks were leading the charge higher.
The Philadelphia Housing Sector Index soared 210 percent from the beginning of 2012 through May of this year. The S&P 500 Index, in contrast, managed a 131 percent increase.
In fact, housing stocks have been a leading sector ever since this bull market began. But since mid-May, the group has tumbled 15.9 percent while the S&P 500 continued to rise.
This reversal of fortune has everything to do with rising interest rates, which may smother home sales.
Rising mortgage rates, together with rebounding home prices, are beginning to cut into sales of existing homes, according to the National Association of Realtors (NAR). The trade group on Monday said pending homes sales fell 0.4 percent in June, compared with a 5.8 percent advance in the previous month.
The average rate on a 30-year fixed mortgage has jumped from 3.35 percent to 4.5 percent since the end of April. That means for a house that costs $250,000, the monthly payments would total $1,980 more per year.
In addition, home prices rose 12.2 percent in May from a year earlier, according to the latest data from the widely followed S&P/Case-Shiller Home Price Index. Nearly every major metro area in the country has benefited from the rebound in housing, with prices up in 18 of the 20 largest cities.
Prices shot up 24.5 percent in San Francisco and 23.3 percent in Las Vegas. Those heady gains are reminiscent of the housing bubble that popped in 2006 and 2007.
In fact, a recent MSN Money article talked about “panic” among would-be homeowners, thanks to a combination of rising prices and mortgage rates. “People now realize that they’ve seen the bottom” in housing, “and they have to hurry [to buy].”
Could a combination of rising rates and prices undercut the recovery?
Even as homebuilder stocks are almost in a bear market — defined as a 20 percent drop — sentiment among companies remains bullish. In fact, confidence among builders in June hit the highest level since April 2006, according to the National Association of Home Builders. In fact, it was the biggest single-month jump in sentiment in more than 10 years.
But housing stocks are telling a different story (see chart above). PulteGroup (PHM) and D. R. Horton (DHI), two of the largest homebuilders, last week reported lower-than-expected orders for new homes. Pulte’s CEO tried to spin the negative surprise, noting that “if higher rates reflect improving economic conditions, we’d expect a housing recovery to remain on track.”
I put more weight on rising or falling share prices than I do on rising or falling sentiment — or comments from management. These are the same guys, after all, who denied the existence of a housing bubble.
The performance of housing — and regional bank — stocks is a leading indicator for the health of the economy. Keep a watchful eye on homebuilders this summer, which is usually a seasonally strong period. If the Philadelphia Stock Exchange Housing Sector Index breaks to new lows, financial stocks may not be far behind.
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