In his testimony to Congress yesterday, Fed Chair Jay Powell stood up to politicians from both sides of the aisle. There was a lot of pressure from Republicans to say that 1970s style hyperinflation was coming but Powell refused to say so. Rather, he said that scenario was “very, very unlikely.” Powell also did not yield to pressures from Democrats, who seemingly wanted him to say that increasing government debt to hand out cash and boosting the already high government spending has had no inflationary effect. He did admit in his prepared remarks that inflation was here to stay in the short-term. However, his comments suggested that the Federal Reserve was not going to be panicked into hiking rates any time soon.
From an investor’s perspective, this means that two seemingly contradictory statements can be true. As I wrote yesterday, companies that benefit from short-term inflationary pressures, such as Alcoa (AA), have a good short-to-medium-term outlook. But, at the same time, the selloff activity related to interest rate hikes can be seen as premature and overdone. As long as the Fed believes in what Powell stated, which is that this is just a temporary phenomenon, prices can continue to rise, and rates will stay low.
There are a couple of stocks that have been sold as if a rate hike is expected any day, creating some great value for bargain hunters.
Take, for example, homebuilders such as KB Homes (KBH) and Beazer (BZH). Both stocks are down significantly from their highs around a month ago, even though the housing market has been booming. The Case-Schiller national house price index is rising at an annual rate of 13% and currently, there are many cases where housing buyers have to beat out many competitors. For example, my son recently had to beat out 47 other buyers to purchase a house in the Dallas area. And yet, stocks have been sold off, resulting in charts that look like this going back to early May:
I guess this would make sense if the high demand and rapidly rising prices for products had led to sky-high P/Es, but that is absolutely not the case. Right now, KB Homes has trailing and forward P/Es of 12 and 7.6, respectively, and Beazer is even cheaper at 8 and 3.5. Obviously, valuation isn’t the issue, and nor is liquidity. Both companies have decent balance sheets and strong free cash flow. So, the only explanation for the 15% to 20% declines in the stock prices is the belief that something will happen that will negatively impact demand, perhaps something like a rate hike.
There are two points to be made here. The first is that Jay Powell’s testimony yesterday, combined with the statement following the most recent FOMC meeting, make that look unlikely. The second is that, even if it were to happen, mortgages would still be cheap as wages start to increase. A 25-basis point hike of the Federal Funds Rate may change the tone, but the immediate practical impact on home buyers will be limited. One could even argue that a policy reversal with the prospect of further rate increases would motivate even more homebuyers to make the move now.
All in all, with input costs for homebuilders steadying as commodity and lumber prices retrace, along with no imminent rate hike and a continued high demand, the short and medium term prospects for homebuilders look good. This means stocks like KBH and BZH are too cheap and their recent selloffs are an opportunity for investors, not a warning.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.