Despite the availability of some of the lowest mortgage rates in 50 years, the demand for housing remains at historically low levels. Lingering post-recessionary pressures and the sluggish recovery, in general, have kept consumers on the sidelines during these challenging economic times.

Through the first half of 2010, domestic housing prospects appeared to be on the rise and many thought the market was nearing a turnaround after a tumultuous 2007-2009 period. Although analysts were aware that the positive momentum was being partially driven by the government’s homebuyer tax credits, it was tough to gauge exactly how much could be attributed to that, and how much could be a function of the overall economic recovery. As it turns out, the government’s assistance was fueling a lot more growth than initially anticipated.

Since the expiration of federal homebuyer incentives in May 2010, demand has weakened considerably and the decline of the U.S. housing market appears to have resumed. In addition to lower demand, elevated foreclosures, mortgage defaults, and capital constraints on developers have all discouraged many homebuilders from exploring new ventures. As a result, housing stocks have underperformed the broader market averages considerably since the beginning of June including industry giants PulteGroup (PHM), D.H. Horton (DHI), and Ryland Group (RYL). Pulte, the nation’s largest homebuilder, has seen its stock price decline over 20% during this period, while D.H. Horton and Ryland shares have dropped about half as much.

Another big factor affecting the struggling domestic housing market is the lack of employment opportunities in the United States. The unemployment rate has swayed back and fourth between 9.5% and 9.7% in recent months, showing few signs of improvement. The correlation between unemployment and home sales is relatively high because consumers who don’t have jobs aren’t likely to have the means to pay a mortgage, and, in turn, are not likely to be in the market for a new home.  Accordingly, we believe a rebound in homes sales remains highly reliant on broader and more sustainable economic recovery, rather than periodic infusions of government assistance. Though the federal homebuyer tax credits were successful in offering a brief boost to demand, the immediate downturn following their expiration magnifies the need for a more permanent solution.

Due to the aforementioned factors, the near-term outlook remains largely uncertain for homebuilders, along with other industries associated with the housing market. In our view, improving conditions within the economy (most notably in labor markets) should help aid a recovery in housing down the road. But for now, these stocks remain speculative until a more sustainable turnaround is in place.  For investors with a high tolerance for risk, there are several riskier stocks within the homebuilding industry that have been discounted in recent quarters, but are well positioned to bounce back in tandem with the economy. Such equities include, PulteGroup, D.R. Horton, Lennar, NVR Inc., and Ryland Group. 

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.