Last week’s decision by the Fed to drop interest rates by 0.50% has churned popular opinion that the homebuilders are set to make another bullish run. Resist the urge to buy the homebuilders for just a minute and I’ll give you a simpler, more effective way to benefit from the Fed’s policy rate shift.
Investors and analysts quickly started touting the homebuilding stocks in the wake of last week’s Fed decision to lower rates.
Names like Toll Brothers (TOL), KB Homes (KBH), and Lennar (LEN) instantly gained attention as investors look to get in front of a wave of home buying that is likely to happen over the next 6-12 months.
It’s true, lower rates are going to bring more buyers into the market, but how they will be buying is more important than what they will be buying.
It’s no secret that the homebuilders have been performing strongly.
Existing homeowners have been unwilling to let go of their houses for the last two years as they’ve been unwilling to sell their homes with low-interest rate mortgages. It’s put the homebuilders in the driver’s seat.
Currently, the homebuilding ETF is leading the major sector ETFs with its 26% year-to-date gains, far more than the popular Nasdaq 100 (QQQ) returns of 16%.
That performance has turned everyone bullish, creating exceedingly high expectations for the homebuilding stocks, expectations that are already prices into their current stock values.
Last night, KB Homes’ latest earnings report missed its earnings per share target, despite strong revenue gains. Shares are trading 5% lower following the report.
Last week, Lennar beat their earnings and revenue targets but the stock is trading 5.35% lower today.
And things are going to get more challenging.
With rates heading lower, we’re already seeing the number of existing homes on the market increase. Owners are looking to cash in on high prices now that it makes more sense to buy another home with lower rates on the horizon.
Meanwhile, homebuilders have been accumulating inventory that will now have to compete with the increase in existing homes that are going on the market.
The bottom line here is that we should expect the environment to get tougher, not easier, for the homebuilders over the next 6-12 months.
Lower rates favor the lenders, not the builders.
Remember that the existing home market is going to start moving again, and each of those transactions is likely to include a mortgage.
Icing on the cake?
For the last two years realtors have been advising their clients that were buying houses with high interest mortgages that they should consider refinancing their mortgage as soon as rates started to drop.
This week’s mortgage applications surged 11% to their highest level in two years as prospective homebuyers prepare to take advantage of lower rates. And this is just the beginning of the wave of mortgage financing to come.
The real winner in the housing market is going to be the lenders, not the builders.
The answer may surprise you, it’s not Wells Fargo (WFC), U.S. Bank (USB), or any of the large banks you would suspect.
Rocket Mortgage – one of the Rocket Companies (RKT) is the largest mortgage lender in the United States, originating 464,363 mortgages worth $127.6 billion in 2022.
I covered the company as one of my Fast Profit ideas in June and now all the pieces are falling into place. (click here to read the details).
Shares of Rocket Companies are trading 36% higher in 2024 as the company has spent the last two years tightening margins and preparing for the run on mortgage business when rates finally fell.
Last quarter, Rocket Companies beat analyst expectations by a penny as revenue grew only 5% on a year-over-year basis.
Despite the phenomenal performance, both fundamentally and technically, Wall Street remains cautious on their outlook.
Current analyst recommendations for Rocket Companies show that zero “0” analyst rate the stock a buy while 15 consider the stock a “hold” or “sell”.
That’s going to change over the next six months as the mortgage market gets back to work.
The combination of technical and fundamental strength along with a shift in sentiment from Wall Street is set to take Rocket Companies back to their all-time highs above $40.
For the average investor, buying the stock is the simplest and best way to go.
The long-term outlook for Rocket remains bullish, putting the stock in the category of a long-term bullish outlook.
Expect the stock to outperform the broader market indices – including the Nasdaq 100 (QQQ) as it holds the potential to double over the next 1-2 years.
For those looking to leverage that expected move, consider using long-term LEAPs options as an alternative to holding the stock.
LEAPs allow investors to control a larger amount of the underlying asset with a relatively small capital outlay. They also provide leveraged returns when compared to the performance of the underlying stock.
Currently, the January 15, 2027 RKT $25 calls are trading for $500 per contract.
That option gives the owner the right to buy shares of Rocket Companies for $25 a share anytime between now and its expiration date.
If Rocket reaches the $40 target anytime between now and January 15, 2027 the option would be worth a minimum of $1,500, a 200% gain compared to a 100% gain on the stock alone.
The value of that option would be considerably higher – along with its returns – if that price target were achieved in the next year.
As always, all investors should obtain education and experience with options trading before adding them to your long-term portfolio.
