January 23, 2023, New York, NY Ken Zener speaks with Norah Mulinda of Bloomberg News.

Kenneth Zener at Seaport Research Partners, who correctly called the performance of US homebuilder shares the past two years, appears to have nailed his latest recommendation on the sector as well.

A closely watched index of homebuilder stocks sank 6% Tuesday, the most since 2022, after industry bellwether D.R. Horton Inc. reported earnings that missed Wall Street projections in areas such as quarterly orders. The firm also said it will lower prices and continue incentives for buyers, disappointing investors who were hoping a drop in long-term borrowing costs in recent months would brighten the outlook. 

The slump in the shares came the day after Zener cut the sector to neutral from buy. He also downgraded firms including D.R. Horton, the largest builder by market value, to neutral from buy. The company slumped Tuesday by the most since 2020. 

Growing expectations for Federal Reserve interest-rate cuts drove the sector to a 35% gain last quarter, its biggest advance since 2020. By Zener’s calculation, that surge more than priced in the magnitude of gains the sector typically sees in the wake of Fed easing. 

He analyzed the past 18 Fed rate-cutting cycles and found that homebuilder shares saw a median return of about 19% six months after the start of easing. With the market anticipating rate reductions will start in March at the earliest, the return potential for the sector has diminished, according to the analyst’s research. 

“We don’t want to overstay our cyclical call” from early November, Zener wrote in his Monday note, a reference to his move at the time to upgrade a slew of homebuilder shares to buy, predicting 25% near-term upside. The homebuilder gauge rose 28% from that point through year-end.

The analyst correctly called a tough 2022 start for homebuilder stocks as well as their rebound, and also foresaw strength in 2023.

In an interview Tuesday, Zener said that while the sector may have hit its peak for now, economic indicators such as employment data will largely guide analysts’ calls going forward. Signs of strength that push up expectations for interest rates will undermine the shares, and vice versa.

Voices of Caution
Zener is hardly alone in voicing caution around homebuilder stocks. Michael Dahl at RBC Capital Markets also has a neutral rating on the sector. 

D.R. Horton’s results did “little to show conviction around meaningful demand improvement following this latest decline in rates, which could provide a reality check for the group after the robust rally,” Dahl said in a note Tuesday.

Read more: Homebuilders’ Wild 2023 Rally Seen Continuing Into Next Year

On the optimistic side this week, Zener said he foresees the industry’s margins broadly bottoming as incentives ease, partly offset by rising costs, including for lumber and labor.

Next week brings further earnings reports from the industry, with NVR Inc. and PulteGroup Inc., the third- and fourth-largest US homebuilders by market cap, scheduled to release fourth-quarter results.

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Justin Cable
Seaport Research Partners