How rate cuts could impact homebuilder stocks

As the market anticipates Federal Reserve rate cuts, Bank of America analysts suggest that homebuilders and building product stocks may have already priced in the expected benefits of lower rates.

In their latest note, Bank of America analysts highlight that housing sentiment has improved, fueled by the recent decline in 30-year mortgage rates from 7% to roughly 6.2%.

However, they caution that "the stock performance has been stronger than the improvement in underlying fundamentals."

Historically, homebuilder stocks tend to outperform in the months leading up to the first rate cut, with Bank of America noting that these stocks have outperformed the S&P 500 in three of the last five rate cut cycles.

They add that building product stocks have shown even better results, outperforming in four of the last five cycles. Over the past three months, homebuilder stocks have surged 26%, and building product stocks are up 13%, compared to the S&P 500's 2% rise.

However, Bank of America emphasizes that "stock performance following the first cut is more mixed," with homebuilders outperforming in three of the last five cycles while building products have underperformed in the same timeframe.

They warn that current valuations are higher than those seen before previous rate cut cycles, with homebuilders trading at over 2x price-to-book and building products at more than 20x price-to-earnings.

While lower mortgage rates are expected to boost new home and renovation demand, Bank of America analysts caution that risks remain, including a potentially weakening job market and already-elevated valuations.

They conclude that while lower rates will benefit affordability and pricing for homebuilders, "mortgage rates have already priced in significant rate cuts."

Source: Investing.com