Will Lumber’s Decline Continue to Boost Home Builders?

"Ahh, home crap home!"

-Tom Hanks as Walter Fielding, The Money Pit (1986)

It seems to reason that when lumber prices are dropping, that Home Builders become more profitable and their stock prices perform better.

On October 6th of last year, lumber prices stood at around $350.20 when they started to fall precipitously. The drop in prices has continued for the last five months, and through Friday’s close are down about 20% during that time.

Meanwhile, the SPDR S&P Homebuilders ETF (XHB) has been on a sweet run. XHB was sitting at $28.02 on October 13th, started to rally a few days ahead of the broader market rebound, and is up 26% over the same five months. That number was above 30%, but Home Builders have given back about 5% or so in part due to the broader market struggles last week.

Even though the stock market was skittish Friday with concerns over a pending rate hike, the fundamentals for homebuilders continue to look solid. Friday’s jobs report showed another 295,000 people were hired in February, the 12th straight month with more than 200,000 new jobs. The unemployment rate also dropped to 5.5%, its lowest level since 2008. Housing starts were down 2% in January given the severe weather conditions, but pending home sales reached their highest level since the summer of 2013 and are up 8.4% year over year. Interest rates are also still at historical lows and the Spring Selling Season is upon us.

So, what then with lumber prices? When we’ve seen a drop like this, how do prices typically react in the next month? If only we had a gauge for the range of probable outcomes….

EidoSearch found 34 similar instances of the current 3 month price trend in Lumber’s history, dating as far back as 1983, and Lumber prices are up 73.5% of the time in the next month and the average return is 5.5% with almost 8x the upside to downside.

One month forward projection for Lumber (LS)

One month historical returns for the 34 most similar instances of Lumber’s current 3 month price trend

Have a great week.

Related Instruments: PulteGroup (PHM), Lennar Corp (LEN), D.R. Horton (DHI), Toll Brothers (TOL), iShares S&P Global Timber & Forestry Index Fund (WOOD)