A long-awaited interest rate cut seems all but certain to happen this week, but homebuilder stocks have been climbing in anticipation of this moment since October 2023, when the Federal Reserve signaled the hikes had come to an end. That leaves the group with little room for error, according to RBC Capital Markets. Analyst Mike Dahl sees the stocks “priced for perfection” as industry fundamentals remain choppy underneath the surface. Stocks in the firm’s coverage universe have “significantly front-loaded expected rate cut benefits, well in excess of prior fed cycles,” he said. Despite that, Dahl expects Toll Brothers , Taylor Morrison Home and Tri Pointe Homes to outperform the cohort. Toll Brothers stock has advanced 46% in 2024, while Taylor Morrison has climbed more than 28% and Tri Point has risen 25%. The S & P Homebuilders ETF (XHB) , which tracks the S & P 500’s homebuilders index, has advanced nearly 26% in 2024, with a 15% surge over the past three months as signs of slowing inflation grew more tangible, and investors became more hopeful rates would start to come down. XHB 1Y mountain Spdr S & P Homebuilders ETF over the past year. According to RBC, the average of the past five Fed cycles saw 12-month stock gains of just 4% for the homebuilder stocks the firm covers, and 15% for the building products companies. Even in the mid-1990s when the Fed orchestrated a “soft landing,” homebuilder stocks saw an average 19% gain, RBC said. “It’s unclear to us that initial rate cuts will do much to spark a meaningful change here (and a deeper/faster cutting cycle would likely indicate a more worrisome fundamental backdrop),” Dahl said. The market is heading into Fed’s policy meeting on Tuesday very confident that an interest rate cut will be made, but the magnitude is a topic of great debate . Traders are pricing in a 59% chance of a 50 basis point cut from the central bank, according to the CME Group’s FedWatch tool . The chances of a smaller 25 basis point cut have fallen to a 41% chance. ‘Caution is warranted’ While the market is looking for a more aggressive move, many economists have been advocating for moderation. One worry that could accompany a deeper cut is that it would suggest Fed officials are fearing the economy is weakening quickly. “Incremental consumer/employment deterioration remains the key risk, as stock performance has been binary in prior cutting cycles, hinging on whether cuts succeed in staving off recession,” Dahl said. “We believe…
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