Despite rate worries, housing market looks good to Home Depot and Lowe's

Housing market looks good to Home Depot and Lowe's

To hear Home Depot HD and Lowe's LOW talk about the housing market, it's healthy and likely to get stronger. If they're right, an improving market should bode well for the economy and, of course, for both companies.

The question is how strong the housing market really will be in 2014. The National Association of Realtors reported sales in October fell 3.2 percent from September to a seasonally adjusted 5.12 million units. That's an annualized estimate of single-family homes, townhouses, condominiums and cooperative apartments.

The sales rate peaked at 5.39 million units in July and August and has fallen 5 percent since. The Realtors blamed higher interest rates and lack of inventory for the October decline. But the odds are that existing-home sales will total about 5.1 million units for the year, up 9.8 percent from 2012 and the best sales year since 2007.

The question about 2014 is all about job growth, the Federal Reserve and home prices. There's lots of talk about rising interest rates and tightening inventories. The rate on a 30-year fixed-rate loan has risen from a bottom of about 3.4 percent early this year to about 4.3 percent now. But data from Bankrate.com shows rates have dropped from their 2013 highs of around 4.67 percent, reached in early September.  

About 2.1 million homes were for sale nationally in October, little changed over the last seven months. At current sales rates, that represents a 5-month supply. Traditionally, a six-month supply of homes is considered normal.

The odds are mortgage rates will hold in 2014 unless the Fed really starts to sharply taper its bond purchases and inflationary pressures start to mount. So far, inflation has been benign. In fact, it is lower than what the Fed wants.

That leaves job growth and prices as the key determinants for housing markets next year. The national unemployment rate was 7.3 percent in October, the Labor Department reported on Nov 8. And the economy added an estimated 204,000 jobs. That number will revised in the November report, due Dec. 6.

Job growth has been slow, but it also has been persistent. Since the jobs market bottomed in February 2010, the economy has recovered roughly 83 percent of the 8.7 million jobs lost between January 2008 and February 2010.

Prices may be an impediment to housing. They're up about 10 percent from a year ago. The median price was $199,500 in October, up 0.5 percent from September and 12.8 percent from a year ago. But the price is hardly uniform. It was $154,700 in the Midwest, $171,500 in the South (defined as every state south of Delaware and Oklahoma) and $284,000 in the West. That reflects high prices in California.

But to hear Home Depot and Lowe's executives talk about the market, rising home prices are a good thing.

"If home prices were to decline, then we might have a different point of view on the housing recovery, but we are not seeing that," said Carol Tome, Home Depot's chief financial officer, during Tuesday's conference call.

First-time buyers are not driving their businesses. It's middle-income and upper-income owners who are seeing the value of their homes rise sometimes for the first time in five years. So, they're finally confident enough to invest in home improvements.

So, they're buying appliances, kitchen cabinets, flooring, new bathroom fixtures and the like. Purchases of $500 or more were up 8.6 percent in the third quarter for Lowe's, compared with just 3.6 percent for purchases of $50 or less. Home Depot said sales of $900 or more grew 10.3 percent from a year ago. That's 20 percent of total sales. Sales of $50 or less -- also 20 percent of sales -- were up just 3.1 percent.

This new round of home investment is barely started. Sales still haven't recovered to pre-recession levels, both companies said. And interest rates haven't been a factor.

That may explain why Home Depot and Lowe's shares have performed so well in 2013. Home Depot is up 29 percent. Lowe's is up 34 percent, despite a 5 percent decline on Wednesday. That has less to do with the housing market than with Lowe's specifically. Fiscal-third-quarter results missed Street estimates and guidance wasn't much better. And it seems to be struggling against a resurgent Home Depot.

But what about new construction. Again, the question is interest rates and job growth. Tom McClellan, editor of the McClellan Market Report, notes that lumber futures prices are rising, suggesting the housing recovery is good at least until March. Then it depends on what the Fed does.

Home building shares have been stronger of late. The iShares U.S. Home Construction exchange-traded fund (NYSE:ITB) had been up as much as 23 percent on the year until mid-May when Fed Chairman Ben Bernanke first discussed the Fed's tapering its $85-billion-a-month bond-buying program. The ETF's price fell back sharply as interest rates moved up on the tapering speculation. The ETF has been rising lately. It's now up 6.3 percent for the year.

What that says is that investors like housing, but they're a lot more cautious than they were earlier in the year.