After the better than expected numbers for November housing starts were announced yesterday, MoneyShow's Jim Jubak, also of Jubak's Picks, crunched the numbers and found some possible solutions for how to play this upwards movement.
I think the market added two plus two and got five yesterday, after the release of better than expected numbers for November housing starts. That doesn't mean, however, that two plus two equals four isn't impressive enough to warrant a look from investors at specific stocks in the housing sector. Two that I think are attractive here are homebuilder Lennar (LEN) and flooring retailer Lumber Liquidators (LL).
In numbers reported yesterday morning, housing starts jumped 22.7% to 1.1 million in November from October levels. That was at well above the 950,000 starts expected by economists surveyed by Briefing.com.
That led to huge gains in housing stocks. Lennar climbed 6.3% on the day. D.R. Horton (DHI) closed up 6.4%. Lumber Liquidators rose 6.1%.
The direction of that move is correct, in my opinion. Housing starts now look likely to run at an average rate of one million a month. The relatively modest extent of the Federal Reserve's taper—a drop of just $5 billion a month, to $35 billion from $40 billion, in its purchases of mortgage-backed securities—isn't likely to push mortgage rates up significantly. And with short-term rates likely, the Fed said on December 18, to stay near 0% into 2015, and with inflation running at less than 2%, there just isn't much upward pressure on interest rates in general, and mortgage rates in particular.
In addition, the December 18 announcement of the beginning of a taper in asset purchases from the Fed, removes a good bit of the uncertainty that has been driving volatility in the housing sector for months. Lennar, for example, has bounced from low to high to low to high with every shift in the market's interpretation of the odds of a Fed taper. For example, on November 11, Lennar traded at $32.58 a share. That was down from $37.38 on October 29. In the December 18 rally, the shares recovered all the way to $37.43.
But there are problems in the sector that say to me, "Watch that math."
For example, the November 1.1 million starts was likely inflated by the uncertainty in September and October over the budget and the debt ceiling. A return to one million starts in December wouldn't be surprising. And it seems like homebuilders, especially, are looking at stagnant or declining margins in 2014. Lennar has told Wall Street that gross margins won't expand further in 2014 and are likely to remain flat at around 25%. That would be a drop from the 26.8% gross margins in the company's fiscal fourth quarter that ended in November 2013.
Those projections from Lennar say watch valuations across the sector. Lennar invested heavily in buying land early in this cycle, so the company is relatively less likely to feel pressure on margins from rising land costs as the housing cycle continues. I calculate a $40 a share target price for Lennar by July 2014. That's only a 7% gain from the December 18 close, so this stock would be much more attractive on the dip. (Investors might see that dip with the slower winter season, but spring weather usually pushes up prices in this sector.)
If you're looking for a dip in a housing related stock, I'd suggest Lumber Liquidators. The shares dropped from $119.44 on November 15 to $89.49 on December 13, before recovering to close at $99.50 on December 18. That's a 17% drop and it makes the gain to my target price of $129 by October 2014 an attractive 30%.
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