If Rate Cuts Materialize, These Stocks Could Be Poised for Big Moves

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Homebuilder stocks surged in July as a cooler-than-expected June inflation report fueled hopes for significant mortgage rate drops this year. It's now more than priced in that we'll get an interest rate cut in September, with the market implying around 100 basis points of cuts by the end of the year. Given that there are only three meetings left on the FOMC meeting calendar for the rest of the year, that means there's a 50bps cut baked into expectations right now.

For homebuilder stocks, that's great news. Lower rates should bring down Treasury yields, which mortgage rates are derived from. Of course, other factors, such as demand for mortgage-backed securities, also plays a role in how low mortgage rates will ultimately go. But it's true that a series of cuts could certainly entice sidelined homebuyers to re-enter the housing market, boosting the outlook of many homebuilders which have been forced to offer incentives to offload their inventory.

With investors rising, a recent dip in various homebuilder stocks is notable. But the question is whether this is a notable buying opportunity, or if these interest rate cuts on the horizon could be a headfake.

I think the former scenario could be more likely moving forward, and as such, would invite investors to at least take a look at these home builders right now.

Key Points About This Article:

• Homebuilder stocks have seen significant volatility in recent years, in part due to shifting monetary policy stances from the Federal Reserve.
• Now, with interest rate cuts on the horizon, many investors are beginning to eye a couple builders that could see big upside from here.
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Lennar Corp. (LEN)

Image of a Lennar office building

Lennar Corp. ( NYSE:LEN ) is a homebuilder that's certainly seen its fair share of volatility this year. In fact, shares of LEN stock have seen five moves of more than 5% in a single day this past year. And despite trending positively of late (largely due to expectations of rate cuts boosting consumer demand for housing), this is a stock that's trading roughly 10% off its March 2024 high. I think that's a buying opportunity.

This year, Lennar's stock hit an all-time high of $178.76, reflecting impressive growth of nearly 40% on a year-over-year basis. I think a move to new highs could be likely, if positive demand translates into lower inventories, and spurs additional permits in key markets.

We'll have to see exactly how hot demand gets following potential interest rate cuts, and not all analysts are sold on Lennar's outlook. In fact, Goldman Sachs recently downgraded the stock to Neutral from Buy with a $174 price target (below its previous all-time high). So, it's certainly not the consensus view that new all-time highs are in order.

That said, with the comapnys' Q2 earnings exceeding expectations, and a $5 billion cash reserve held at the company, Lennar's current valuation of $49 billion certainly seems reasonable. This is a stock that's trading around 12-times earnings, and provides a small 1.1% dividend yield as well. That's hard to find in this market, to be sure.

If consumer confidence rebounds, and buying activity picks up, Lennar is a top homebuilder investors may kick themselves for not buying into what could be the next cycle higher for housing.

D.R. Horton (DHI)

D.R. Horton logo

D.R. Horton ( NYSE:DHI ) is another major player in the homebuilding scene which has seen strong performance over the past year. Like Lennar, DHI stock is trading near its all-time high, as investors price in a rosier demand outlook and strong past results into their valuation models.

The company now projects it will deliver 90,000 to 90,500 homes in fiscal 2024. These numbers are slightly above its previous estimate, and suggest that the strong demand D.R. Horton's management team expects to see moving forward will continue. Now, affordability challenges have been noted as headwinds, and the supply of new homes on the market has ticked up. But on a historical basis, supply of existing homes remains limited, and new homes could be attractive opportunities for many homebuyers in an economy that's strengthened by lower interest rates.

As is the case with all homebuilders, we'll have to see just how aggressively the Fed cuts rates. But D.R. Horton does expect its cash flow to surge next year as its rental investments stabilize, which should boost shareholder returns. I think this is a stock that could have much more room to run here, and its momentum is palpable. Of course, anything is possible, and a recession could be around the corner. But if the market's consensus view that a soft landing takes hold, this is a top home builder that could have big upside from here.

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