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Rebounding consumer confidence helps homebuilder stocks like NVR

Brent Nyitray, CFA, MBA

The Investor’s Business Daily/TechnoMetrica Optimism Index is considered a preview of the upcoming consumer confidence indices

The Investor’s Business Daily/TechnoMetrica Optimism Index has a good track record of predicting how the two major consumer confidence indices—the Conference Board and the University of Michigan Consumer Confidence indices—will look when they’re released later in the month.

The index has three major components: the six-month economic outlook, the six-month personal financial outlook, and confidence in federal policies

Consumption is the major driver of the U.S. economy, and it accounts for 70% of GDP. Consumption has been relatively subdued since the recession began, as Americans have boosted their savings rate and spent only on essentials. The real estate bubble drove consumption in the mid-’00s as people took out cash refinances and spent the extracted home equity. This increased the cost basis for many people’s homes and kept them vulnerable when house prices collapsed. As a result, they’ve focused more on paying down debt than on spending.

Highlights from the report

The IBD/TIPP Optimism Index increased 2.9 points, to 48 versus 45.1 in March. It’s above its 12-month average of 44.9. A reading below 50 indicates pessimism. The six-month economic outlook gained 2.9 points, to 45.7. The personal financial outlook increased 3.8 points, to 58.2. This number has been increasing due to increased asset prices. Finally, confidence in the government rose for once, to 40.2. Overall, Americans have little faith in government.

Of respondents, just under half think the U.S. is still in a recession. Respondents seem to be more bullish about their own personal situation than the economy in general. We’ve seen the same phenomenon in the Bloomberg Consumer Comfort Survey.

Implications for homebuilders

Buying a home (particularly a new home) requires a great deal of confidence in the future. Indeed, KB Home said consumer confidence is even more important than interest rates. Homebuilders need consumers to be comfortable in their personal situations, the economy, and the future of home prices. The index shows that people are more confident in their own situation than they are in the economy in general.

For homebuilders, it pays to focus on the segments of the market that seem to have the most confidence, and that means people with appreciating homes and portfolios. This means the luxury and move-up buyer. The most obvious beneficiary of this dynamic would be Toll Brothers (TOL), which focuses on the luxury and move-up market. Its average sale price is $694,000. The other beneficiary would be NVR (NVR), which has an average selling price of $375,000—although NVR is exposed primarily to the East Coast. The East Coast has been lagging the West Coast in price appreciation, although some of the latest indices show that activity is starting to pick up, while shortages are cooling off on the West Coast. Meritage (MTH) is another builder focused on the move-up buyer. PulteGroup (PHM) and D.R. Horton (DHI) have lower price points and focus more on the first-time homebuyer.

To learn more about investing in homebuilders, see House prices continue their march higher.

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