Is the homebuilders' rally over?

The housebuilders have seen a slow start to 2016, with market valuations across the industry easing back. However, we take a look at two of the main players alongside some of the considerations that will impact the industry over the coming months and year.

Source: Bloomberg

Housebuilders provide a contentious investment opportunity in the UK, as the prospects of rising interest rates coupled with a slowing construction sector provide big question marks over whether the sector is still a buy.

It is interesting to note that while the past two years has tended to see little gains from a market valuation point of view, the industry has performed remarkably well from a fundamental perspective. Looking at the Bloomberg UK homebuilder index as a proxy for the sector, rising profit margins, return on assets and return on equity provides a clear view that the industry is moving in the right direction. With fundamental improvements outstripping any share price gains in recent years, we have seen the price to earnings ratio tumble by almost 60% in the past three years. The question is whether this will be enough to attract new investors to a sector which has obvious long-term risks.

The dominant risks for the industry will revolve around the market response to rising interest rates, with many predicting that highly leveraged markets such as London will be hit hardest by any significant rise. The buy to let market is full of investors who have bought multiple properties, using one as collateral for the next, and so on. Should we see rates rise significantly, the impact that will have to mortgage payments, foreclosures, demand and subsequently property prices should not be underestimated. It is also worth factoring in the Brexit argument, where stocks that are heavily reliant upon the UK economy will likely suffer should the UK leave the EU.

Conversely, there is undoubtedly a great interest in the creation of new houses in the UK, a topic the 2016 London Mayoral election was centred upon. The reallocation of land for new developments will invariably rise under Sadiq Khan and it is likely that the government follows suit to ensure they are not left behind by a Labour MP. With that in mind, a rise in activity would further improve the fundamental picture for the industry, which at some point would be expected to be reflected in the share price.

Taylor Wimpey

One of the biggest firms in the industry, Taylor Wimpey has announced that it sees a ‘very positive’ housing market in the UK, with healthy confidence and demand. With a significant rise to the dividend payout this year, it is clear that the firm is particularly bullish going forward.

The weekly chart shows that despite the circa 400% gain over the past five years, we have seen capital growth tail off significantly in the last 11 months, forming a descending channel formation. This is somewhat similar to the 2013-14 consolidation which lasted 15 months. Ultimately a break through the £2.07 resistance level would be required to signify a likely next leg higher for the shares. There is no doubt that a strong uptrend remains intact and with the company clearly very bullish about the future, another break higher is certainly a possibility.

Barratt Developments

Ranked number one in the UK for the latest completion figures, Barratt Developments is a firm at the forefront of the sector. Much like its competitors, it has had a great run since the lows of the financial crisis, with shares rising 1700%. However, the past ten months have been less impressive, with shares at one point losing 26% from the highs in September 2016.

However, on the daily chart it is clear that we could be on the cusp of a bullish breakout as price attempts to close above outside of a wedge pattern. A falling wedge pattern is bullish, especially in an uptrend. Thus we have a good chance of pushing higher once more, dependent upon whether this breakout holds. As such, a closed daily candle above £5.89 would be a strong indicator that this consolidation is over and that the uptrend is set to continue.

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