Last weekend, I took a long run through one of my favorite areas of Atlanta. Along the way, I noticed something interesting: “For Sale” signs are starting to pop up everywhere.
But that’s not what really caught my eye…
What grabbed my attention were the “Price Reduced” tags hanging below those signs. I’ve seen a few more of them every week.
For the past couple of years, the housing market has been running red hot. Prices climbed to astronomical levels while inventory stayed incredibly tight. If you’ve been in the market for a house, you know exactly what I’m talking about.
But now, we’re seeing a major shift. And it could spell trouble for homebuilder stocks.
A Perfect Storm for Housing
Here’s the situation we’re facing: Home prices have been rising much faster than wages for years now. That might work in the short term, but it’s not sustainable.
Think about it… How can people keep buying more expensive homes if their paychecks aren’t keeping up?
They can’t. And that’s just the beginning of our housing market problems.
Right now, we’re caught in a tricky situation. If interest rates start falling (as many expect), we’ll likely see a flood of new listings hit the market. All those homeowners who’ve been “locked in” with their low mortgage rates might finally decide to sell.
But if rates stay high? Well, homes remain unaffordable for many buyers, especially first-time homebuyers who don’t have equity from a previous home to help with the down payment.
Either way, homebuilders could be in for a rough ride.
How to Play the Housing Slowdown
Now, since we’ve been enjoying a bull market for the last several quarters, I’ve been mostly focusing on positive stocks that are trending higher. But after a healthy bull run for certain areas of the market, vulnerable stocks can experience some nasty declines.
This could be one of those times.
Several major homebuilders look particularly vulnerable right now:
- Lennar Corporation (LEN) has seen its stock price climb despite these housing market warning signs.
- D.R. Horton (DHI) continues to trade near all-time highs.
- Toll Brothers (TOL) focuses on luxury homes, which could be hit especially hard in a downturn.
All three of these companies have benefited from the housing shortage of the past few years. But with inventory rising and affordability stretched to the breaking point, they could be in for a significant pullback.
My former hedge fund mentor Bill taught me that the best trades often come when you spot a disconnect between what Wall Street believes and what’s actually happening on the ground.
That’s exactly what we’re seeing in housing right now.
A Safer Way to Play the Downside
If you’re interested in profiting from this situation, consider buying put options on the iShares U.S. Home Construction ETF (ITB). This gives you exposure to the entire homebuilding sector without taking on single-stock risk.
Put options let you profit if stocks fall while limiting your potential losses to just the amount you invest. Think of it as insurance against a housing market decline.
For more conservative investors, you might want to simply reduce your exposure to homebuilder stocks if you own them. Sometimes the best trade is avoiding losses altogether.
Remember, I’m not suggesting that housing is headed for a 2008-style crash. But with prices this high and affordability this stretched, something has to give.
The housing market might be about to learn the same lesson we see over and over in market cycles: Any area with too much speculation can be vulnerable once the excitement wears off.
Here’s to growing and protecting your wealth!
Zach Scheidt
P.S. If you want to learn more about how to profit from market downside, check out my Speculative Trading Program.