QE3 – Federal Reserve Chairman Ben Bernanke's $40 billion-a-month booster shot – could be just what the doctor ordered to keep homebuilder stocks surging.
The Fed's buying of mortgage-backed securities (MBS) is designed to help push down 30-year mortgage rates — a major incentive for consumers to buy a house.
The strategy is already working. Last week, just a month after QE3 was announced, mortgage interest rates fell to the lowest level on record.
The average 30-year loan stood at 3.39% as of Oct. 11- down from 6.1% at the start of the recession in December 2007.
And the Fed has said it plans to keep its own federal funds rate, a benchmark for interest rates, at "exceptionally low levels" at least through mid-2015.
Such policies, designed to jumpstart the economy by boosting the housing market, necessarily benefit homebuilder stocks as well.
"You get more benefit when people buy homes," Bernanke says. "It's the purchases of new homes that generate the construction activity, the furnishing, all those things that help the economy grow."
Big Homebuilder Stocks Thriving
While the recession was driving many small, private builders out of business, large publicly traded companies — who build 30% of the nation's new homes — weathered the storm by cutting back on projects, driving hard bargains with suppliers, and using cash on hand to scoop up cheap properties.
In fact, builders cut back so much during the downturn that they didn't add enough homes to keep up with population growth, Seth Ring, a vice president at Toll Brothers Inc. (NYSE: TOL), told Bloomberg.
There's only about six months' supply of new and existing homes for sale nationally-roughly half the amount available when supplies peaked in summer2010.
Now many of the big players are busy directing construction crews running giant earthmovers, putting up roads and other infrastructure so model homes can open in 2014.
The renewed burst of activity, coming after a four-year slump caused by the bursting of the housing bubble, has sent homebuilder stocks on a remarkable run this year.
Recent earnings reports have told the same story.
Toll Brothers posted blowout third quarter earnings, making $61.6 million in the quarter ended July 31-almost 50% more than the same period in 2011.
KBHome (KBH), which serves first-time buyers, reported quarterly earnings of $3.3million on Sept 21-its first third-quarter profit since 2006.
And builder confidence rose for a fifth consecutive month in September to a level of 40, its highest reading since June of 2006.
No wonder the Standard & Poor's Supercomposite Homebuilder Index of 11 companies is up 60% so far this year.
Given this kind of momentum in the housing sector, QE3 should keep the good times rolling for homebuilder stocks for at least another 12 months.
QE3 Helping Mortgage Lenders, Too
Money from the Fed's spigot has also found its way to the bottom line at the country's biggest mortgage lenders.
Wells Fargo & Co. (NYSE: WFC) and JPMorgan Chase & Co. (NYSE: JPM), the largest U.S. home lenders, on Friday posted third quarter profits that were buoyed by government policies intended to help borrowers MSN.com reported.
And the Fed's mortgage buying is fattening profit margins, letting the banks earn more on every home loan they sell.
"We believe the housing market has turned the corner," JP Morgan CEO Jaime Dimon said in a statement.
Investing in Homebuilder Stocks
While the lenders and homebuilders celebrate their rising profits, investors need to decide whether joining this party makes sense for them right now.
With signs increasing that the housing market has finally reached a bottom and QE3 encouraging lending and buying, homebuilder stocks should have plenty of upside from here.
Still, after their huge run-up this year, some investors may want to take a more cautious approach to the sector.
Both funds provide diversity by owning some of the biggest builders, but dilute their impact by holding other related housing businesses, such as Lumber Liquidators Holdings Inc. (NYSE: LL), The Home Depot Inc. (NYSE: HD), Pier 1 Imports Inc. (NYSE: PIR), Williams-Sonoma Inc. (NYSE: WSM), and Whirlpool Corp. (NYSE: WHR).
The S&P Homebuilders ETF is up 46% YTD, while the iShares DJ U.S. Home Construction Index is up 66%.
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