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TheStreet Open House

Housing Sector Threatened by Spiraling Economic Trend

NEW YORK (TheStreet) –A string of negative housing data in July has jeopardized future price gains in iShares Dow Jones US Home Construction (ITB) and SPDR S&P Homebuilders (XHB).

The home construction index is made up mostly of Lennar  (LEN), DR Horton  (DHI), Toll Brothers  (TOL), Home Depot  (HD), and Lowe's  (LOW).

Meanwhile, the homebuilder's index is made up of iRobot  (IRBT), Restoration Hardware Holdings  (RH), Standard Pacific  (SPF), Williams-Sonoma  (WSM) and Ryland Group  (RYL), with different weightings for both indexes and some overlapping companies.

Read More: Home Depot, Lowe’s Estimates Cut After Warnings From Floor, Farm Retailers

A custom index created below aggregates economic data on U.S. housing starts, building permits, and new family homes sold, thus favoring trends in the initial construction phase of the housing sector.

The graph shows that since its lows in 2009, the index has rebounded sharply higher, but has largely declined for the past two years. Many analysts have tried to explain the situation away by attributing the trend to poor weather in the first quarter, but considering the length of the present downtrend in the indicator, transitory factors don't look to be in play.

Housing data courtesy of St. Louis Federal Reserve

In reality, stagnant wage growth and a spike in 30-year mortgage rates last year from 3.5% to around 4.5% have been the main culprits in the decline in new home activity. As homebuyers have dealt with lower wages to pay for higher mortgages, many have chosen to simply rent as opposed to purchase.

Wages and mortgage rate economic data courtesy of TradingEconomics.com

The economic factors weighing on housing have begun to spill over into equity markets as well. Both the home construction and homebuilder's index are trading near yearly lows this week, and look to have broken major price support, signaling more declines may be in the works.

Read More: Housing Bulls Target Toll Brothers

It is unlikely that mortgage rates significantly drop in the near future, even as long-dated Treasury bonds continue to trend higher. Similarly, issues with economic growth and the true strength of the labor market could hold back demand for new homes.

Ultimately, the new home market looks to be saturated after rebounding sharply from the lows in 2009 to 2012. Fresh demand from millennial home buying could spur more activity in the market, but that seems unlikely for now. Equities with a stake in homebuilding and construction look to be forming major topping patterns and could begin a cyclical bear trend lower as the Federal Reserve prepares to raise interest rates in 2015.

ITB Chart
ITB data by YCharts

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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