Outperforming the market by a wide margin, with a year-to-date increase of 79%! Can the US stock construction sector continue to rise next year?

Zhitong App has learned that bond yields are currently falling, and Wall Street expects this upward trend to continue until 2024. With the anticipation of rising interest rates in 2023 leading to a surge in mortgage rates, residential construction stocks are expected to achieve the largest annual increase in over a decade.

When interest rates rise, housing construction stocks typically come under pressure. This year, however, the situation is different. Strong demand coupled with tight inventory has outweighed the impact of high borrowing costs. As a result, the stock prices of the residential construction industry have experienced a significant increase and are expected to reach a historical high by the end of 2023. Currently, the industry has risen by 79%, far surpassing the 24% increase of the S&P 500 index.

Kenneth Zener, an analyst at Seaport Research, accurately predicted the performance of this industry for two consecutive years. He believes that regardless of whether the Federal Reserve will cause a soft or hard landing for the US economy next year, the expectation of interest rate cuts will continue to favor the performance of residential builders over the broader market. Zener currently has a buy rating on all residential construction stocks, with only one exception.

Michael Rehaut, an analyst at JP Morgan, is also optimistic about the industry's performance in 2024. He points out that his recent revisions to earnings expectations and upward adjustments to target prices may "ultimately prove to be conservative."

In addition, Rafe Jadrosich, a US Bank analyst, believes that supply chain dynamics will improve next year, and lower interest rates will boost sales and profit margins as the construction industry reduces incentives. Anthony Pettinari of Citigroup asserts, "Although the stock market is booming, the market has not fully absorbed the expectation of a decline in rates in 2024."

Zener said, "Even if a decline in rates increases inventory, the market has already prepared itself as it shifts from new home sales to existing home sales." Stuart Miller, Co-CEO of Lennar Corporation, stated during last week's earnings conference call that existing homeowners who ultimately decide to sell their homes will be looking for new residences, further stimulating demand. It's a "zero-sum game."

Tyler Batory, an analyst at Oppenheimer & Co, said in an interview, "Even when mortgage rates rise to 8%, demand is still not a problem. If rates are 5% or 6%, how will demand be? You would think the situation would be even better." According to Seaport's analysis, since 1957, except during periods of high resale inventory, the real estate industry has outperformed the S&P 500 index 9 out of 10 times when interest rates are falling. Currently, there is no expectation of oversupply.

However, BTIG analyst Carl Reichardt warns that the industry may have reached its peak.

Reichardt said, "Most of the stocks I cover are reasonably valued," adding that investors need to see better-than-expected earnings growth in the long run.

He said the next catalyst will be the golden season for buying and selling - spring, when interest rates will either stabilize or decline.

He said, "If interest rates decline and continue to decline, Wall Street's assumptions about sales rates could be significantly underestimated, and the construction industry will do better and be more profitable."

Zena said it is certain that the residential construction industry has early-cycle attributes, which means that initially bearish economic or interest rate corrections can have a significant impact on the industry, and this is an inevitable risk. Therefore, if the risk of an economic downturn increases, a situation similar to 2023 may occur, with a brief market downturn of two to three months followed by a significant rebound.