What Fed Rate Cut? 5 Reasons Why Housing ETFs Are In Trouble

The Fed has finally opened its crisis-era playbook and cut its benchmark interest rate to zero and launched a new round of quantitative easing worth $700 billion. It reminds us of the 2008 initiatives taken by the central bank — the only difference being that the Fed had to act pretty promptly this time to contain the coronavirus outbreak (read: Must-Watch ETF Areas on 2nd Fed Rate Cut of 2020 & QE Launch).

Many may think rate-sensitive sectors like housing may rally as lower rates should drag mortgage rates down and boost buyers’ ability to purchase homes. But it’s not that simple this time as the coronavirus scare hasn’t spared the sector.

In the past month (as of Mar 16, 2020), housing stocks and ETFs have underperformed the broader market massively despite Fed’s rate cuts. Key housing stocks lost in the range of 41% to 49% while the S&P 500-based ETF (ASX:SPY) lost about 29%. iShares U.S. Home Construction ETF (WA:ITB) and SPDR S&P Homebuilders (NYSE:XHB) ETF XHB were off about 60.1% and 41.6% in the past month (as of Mar 16, 2020).

Let’s find out why.

Mortgage Rates Not Likely to Follow Treasury Yields Blindly

Like many analysts, we believe the decline in mortgage rates would be slower than that in long-term U.S. treasury bond yields amid the massive Fed rate cut and the restart of QE. Investors should note that a decline in rates in March has actually boosted mortgage refinances.

Higher volume and “increased risk to mortgage investors from all those refinances” will likely result in a slower decline in mortgage rates than in treasury yields.Also, “mortgage bonds are considered riskier than government bonds, they tend to be slightly higher than 10-year rates,” per a strategist(read: Must-Watch ETF Areas on 2nd Fed Rate Cut of 2020 & QE Launch).

Coronavirus to Push Material Prices Higher

U.S. building product imports from China make up about 30% of all U.S. building product imports. With global communications and trade nearly coming to a halt, one can expect supply disruptions, higher material costs and slower project completions, per Richard Branch, chief economist for Dodge Data & Analytics, as quoted on constructiondive. However, big builders are yet to report any major supply chain disruptions, per CNBC.com.

More Labor Shortage in the Cards?

The sector is already affected by labor shortages. Now with cities on lockdowns and people under quarantine, the shortage in labor might expand. Construction Dive survey shows that 70% workers is suffering from anxiety, while 14% is sick. Local government shutdowns are having 10% impact.

If there is any virus contamination at construction sites, inventory of homes will get severely hurt. The sector is, in any case, facing inventory pressure. At the end of January, there were 1.420 million houses available, enough only for 3.1 months (if these are sold at January’s sales pace).

Stock Market Crash = Reduced Wealth Effect

The bloodbath in Wall Street will result in lower wealth effect for many investors. Wealth effect suggests that people spend more as the value of their assets rise. So, luxury builders like Toll Brothers (NYSE:TOL) will likely be hit hard, per some analysts.

Bank of America (NYSE:BAC) downgraded Lennar (NYSE:LEN) , Toll Brothers and NVR (NYSE:NVR) , saying that “we would be remiss to assume no impact on end-market demand from COVID-19,” though the bank is still bullish on sector fundamentals.

No Spring Selling Season Tailwind This Year?

Most importantly, the coronavirus attacked the housing industry in its busiest selling period, Spring. Normally, the season starts in March and lasts through May-June, thanks to warmer weather conditions after a chilly winter and buyers’ tendency to move into a new house before the next school calendar starts. Any damage to business during this key period will surely not bode well for the space.

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