Housing stocks have a shaky foundation.
Shares of the homebuilders have been racing higher over the past few months in anticipation of the Fed lowering interest rates. The thinking is that lower rates will make housing more affordable, and that will prove beneficial to the housing stocks.
It’s the same thinking that ignited a rally in the homebuilding sector last year. Shares of the S&P Homebuilders ETF (XHB), for example, bottomed in July 2024 near $98 per share. Then, as the market priced in expectations of a Fed rate-cutting cycle, XHB rallied 30% over the next three months.
We’re seeing similar action right now.
In early June, XHB was trading near $93 per share. It traded as high as $117 last week. That’s a 26% gain in less than three months – as the market discounts the potential for lower interest rates.
But, here’s the thing…
When the Fed started cutting short-term interest rates last September, long-term rates moved higher. In other words, buying a new home was less affordable.
And, the homebuilding stocks fell… hard.
Look at this chart of XHB…
Housing stocks peaked in mid-September, trading around $124 just as the Fed started lowering short-term interest rates.
Three months later, XHB was trading near $102. Just about all the gains leading up to the rate cut evaporated.
The rally was based on a false premise. Housing stocks rallied on the mistaken belief that if the Fed lowered short-term rates, then long-term rates would fall as well.
That’s not always true. While the Fed can set its target for short-term rates, it has no control over what happens to long-term rates. And, in the absence of Quantitative Easing (when the Treasury floods the market with newly printed dollars), and in the presence of an inverted yield curve, cutting short-term rates will cause long-term rates to rise.
That’s what happened when the Fed started lowering rates last year. And, we’re likely to see a repeat of that action if/when the Fed lowers rates following its FOMC meeting on September 17.
Housing stocks, which have been rallying on the same false premise that shot them higher last year, are vulnerable to a decline as investors realize that lowering short-term rates does NOT lead to lower long-term rates.
Best regards and good trading,
Jeff Clark
Editor, Market Minute
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