However, by early 2013, optimism over a housing recovery pushed valuations to a 14% premium to the broader market. This left the stocks exposed when rates started to rise last spring. While valuations have come in considerably – the industry now trades at a 35% discount to the market (using the same indices for measurement as I mention above) – the stocks are still not particularly cheap.
If real interest rates start to rise again, as I expect they will, these stocks should be more vulnerable than most sectors. In the past, the level of real long-term interest rates has explained roughly 60% of the variation of the homebuilder industry’s value relative to the broader market (see the chart below). In other words, when and if real rates start to rise, the industry’s valuations may not provide enough of a cushion. For now, I’d look for an even bigger discount before recommitting to this sector.
Sources: Bloomberg, BlackRock research
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog and you can find more of his posts here.
Funds that concentrate investments in a single sector will be more susceptible to factors affecting that sector and more volatile than funds that invest in many different sectors.