Man sitting on doorstep of home for sale.

Housing data has been depressing.

When talk of a recession comes up, housing weakness is a typical justification as to why we are in a recession. But what if bad news is good news? Hear me out.

In general, stocks “price in” bad news early and they tend to rebound before the worst shows up in the economic data. Stocks are forward looking, and economic data is mostly backward looking. Lately, the stock market has been effectively absorbing weak economic data. Housing-related data has accounted for a lot of that data, but not all of it. Could it be that the market is beginning to bet on the economy bottoming soon (if not already), and quickly moving past all this negative news?

Let’s look at the housing market for clues.

The bad news first

Brace yourself, this isn’t pretty. You don’t have to look far to see a bleak housing picture. New and existing home sales have fallen dramatically. This week we learned July existing homes sales declines are picking up steam, with July marking the 12th consecutive month of decline. Not surprisingly, homebuilder sentiment plunged into contraction territory for the month of August, which was the first reading under the key 50 level since the onset of COVID.

Chart titled U.S. Housing Starts Fall From April’s Peak. Higher Interest Rates Weigh on the Real Estate Market. Chart dates from January 2000 to July 2022. The US Housing Starts (Millions) begins at just above 1.5 million, gradually increasing in January 2006 to just below 2.5 million with a sharp decline in January 2009 to just below 0.5 million. Then housing starts steadily increase to 1.5 million until July 2022. Source: Ally Invest, St. Louis Federal Reserve

 

That’s not all. Housing starts, a key indicator of economic activity, declined nearly 10% in July. Meanwhile, more prospective home buyers are backing out of deals. Data from Redfin show 16% of homes that went under contract last month fell through, up from just 12.5% in July last year. Why are folks pulling out of deals? It’s not employment concerns, as the jobs market remains robust. It’s likely an affordability issue as home prices and borrowing costs rise together. The National Association of Realtors confirmed what so many would-be first-time buyers feel: Affordability is at the lowest level since June 1989.

What’s moving in the right direction

I told you that was going to be depressing. Now that we got that out of the way, let’s talk about glimmers of hope underneath the surface. Inventory of existing homes for sale has been rising, and at 3.3 months’ supply its the highest level since August 2020. Granted, there is still much work to be done as that level is still below the 6 months of supply that is historically considered balanced for the housing market. Home prices are starting to moderate from the double digit increases that became the norm in the post-pandemic world. Over time, more houses on the market at lower prices will spur demand.

Another silver lining in the housing market is commodity prices easing: The price of lumber is down 65% from its pandemic high. As the input costs decline, it becomes cheaper to build a house. Another positive trend lately has been moderation and stabilization in the mortgage rate market. After surging above 6% in June, the average rate for a conventional 30-year mortgage has settled into the 5% to 5.5% range for now. Maybe the market is realizing that under any scenario (a hard landing, soft landing, or something in between) peak rates may be in. These types of trends are important to improve the affordability constraint on many looking for a home.

Finding strength in housing stocks

Despite what feels like a long road ahead for the housing market, price action in housing-related stocks is telling a more upbeat story. Since mid-June, the S&P Homebuilders ETF (XHB) has gained 30%, well above the 17% gain in the S&P 500 over the same time period.

The pop in the homebuilders ETF follows a 40% plunge between December and its June low. Over that period, investors priced in a severe slowdown in housing activity before much of the negative economic data was even seen.

To be sure, many of the homebuilders expect demand for new homes to cool in the coming months, driven by interest rates and inflationary pressures. Despite this outlook, the stocks reacted well to recent earnings reports. And while their price-to-earnings ratio has begun to lift off depressed levels, their valuations remain cheap by historical standards.

Chart titled Homebuilder Valuations Back to Pandemic Lows. Uncertainty about Demand Has Weighed on the P/E of these Stocks. Chart dates from August 2019 to June 2022. The DHI Stock is at 10 times in August 2019 dipping to 6 times in March 2020, rising again in June 2020 to 15 times and steadily decreasing to 6 times in June 2022. PHM Stock is at 9 times in August 2019 dipping to 4 times in March 2020, rising to 12 times in June 2020 before declining to 4 times in June 2022. LEN stock is at 9 times in August 2019 dropping to 4 times in March 2020 with an increase to 15 times in May 2020, with a decline to 7 times in June 2022. Source: Ally Invest, S&P Capital lQ

Looking beyond the homebuilders, shares of home improvement retailers Home Depot and Lowe’s have also performed better than the broad market during the summer rally. This week both companies provided guidance that were better than feared and suggested demand for home projects is improving.

While none of these housing focused companies signaled an all-clear signal, investors seem to be focused on the possibility of better times ahead for housing.

The bottom line

The housing market needs to cool off. There are indications that is happening, and it’s not crushing the economy. I see the sharp rally in homebuilder stocks as a sign that the worst could be in the rearview mirror for investors and recent economic gauges point to some normalization occurring over time.

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Headshot of Lindsey BellLindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.

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