Homebuilding stocks get another burst of outperformance

A better-than-expected earnings report from luxury homebuilder Toll Brothers is giving a fresh burst of momentum to homebuilding stocks on Wednesday.

Toll Brothers brought in $482 million in profits — 10% better than expected — on slightly better than expected sales of $2.73 billion. Profit margins, on an adjusted basis, of nearly 29% were a key driver of outperformance. Costs only rose slightly.

The stock soared on the report, pulling along share prices of competitors and extending a solid run of outperformance for the sector.

The angle of incline for homebuilder shares has risen sharply as inflation has softened in recent months, and investors have concluded that the Fed is all but certain to cut interest rates when it meets next month. (Though there remains some debate about how big a cut it will deliver.)

Of course, the housing market is the example par excellence of an interest-rate sensitive sector of the economy. The expected decline in Fed rates has been transmitted through the bond market into a drop in mortgage rates, which are now around 6.50% for the 30-year fixed.

That should boost activity among homebuyers. But, for my money, the remarkable thing about the recent rise in home builder share prices is that it comes amid a remarkable dearth of actual homebuilding. Housing starts tumbled to a four-year low in July — which, to be fair, was likely affected by bad weather — but still!

How does this make sense? Well, believers in the all-seeing power of financial markets might argue that perspicacious traders are simply pricing in the uptick in activity that they see coming in the future as mortgage rates move lower. Slightly more cynical observers might simply note that the current state of affairs in the housing market — low inventory, high prices — means that homebuilders don’t have to build as much to make the amount of money Wall Street expects. Probably a little bit from Column A, a little bit from Column B.