Dow sinks nearly 400 points, yields rise to 2024 highs

Wedbush on Tuesday downgraded shares of five homebuilder stocks, citing seasonality headwinds during what it called the most “normal” year for housing trends since 2019.

The firm downgraded all five stocks to Underperform from Neutral, lowering its price target on Century Communities (CCS) to $82 from $92, LGI Homes (LGIH) to $74 from $88, Meritage Homes Corporation (MTH) to $148 from $155, while keeping its price targets unchanged on DR Horton (DHI) and Lennar (LEN) shares.

“No year in homebuilding ever follows a precise timeline of perfectly rising demand in the spring followed by a seasonally normal decline in demand into the summer,” wrote Wedush analyst Jay McCanless.

“However, 2024 has been the most ‘normal’ year we have seen for the home building industry since 2019 in terms of normal seasonality. Consequently, we believe these names could see a normal seasonal stock price decline into the summer especially after the seasonal trade window closes in April/May.”

The firm, notably, kept earnings estimates unchanged for all five stocks.

The bearish call comes as all five names, save for Lennar, have underperformed the iShares U.S. Home Construction ETF (ITB) since the beginning of the year.

“We think this underperformance could worsen if land acquisition and development costs continue rising and if lumber prices continue appreciating,” McCanless wrote.

Higher for longer interest rates and a lack of housing supply have allowed builders to focus their attention on an underserved segment — the entry-level buyer. Builders have offered price cuts and incentives to drive up volume. But that strategy has negatively squeezed gross margins.

McCanless anticipates the same storyline will happen in the second quarter of this year as mortgage rates remain near highs of the cycle. The 30-year fixed rate loan inched down to 6.79% from 6.87% a week prior, according to Freddie Mac.

Many housing economists believe mortgage rates are likely to decline in the back half of the year as the Federal Reserve cuts interest rates. But McCanless doesn’t think the move will be that mechanical.

“We think that is still the consensus view in the market, but we are taking the opposite view on that front because we believe mortgage originators (bank and nonbank) are unwilling to bear the prepayment risk without being compensated for that risk,” he noted.

McCanless also notes the spread between the 30-year mortgage and the 10-year Treasury is “artificially wide” today to account for refinancing risk.