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Why the FOMC and earnings drove bonds, REITs, and builders

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The ten-year bond is the basic driver of REITs and homebuilders

Long-term interest rates are priced off the benchmark long-term bond, which is the ten-year Treasury. These days, the ten-year bond reacts to economic data through the Federal Reserve’s asset purchase program, also known as quantitative easing (or QE). As a general rule, economic data that shows weakness is bond bullish (positive). However, data that shows strength isn’t necessarily bond bearish (negative).

The FOMC tapers, and mixed economic data

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Last week had some important data points with the FOMC meeting and also some key economic reports. The Fed decided to make another reduction in asset purchases, which bonds and MBS took in stride. Durable goods orders came in much weaker than expected, while GDP came is as forecast at +3.2%. Weakness in emerging markets has been driving activity in the bond market recently.

Homebuilder earnings and M&A

We had earnings from D.R. Horton (DHI) and PulteGroup (PHM) last week. Both companies reported strong earnings and noted that traffic seems to be higher this January. The homebuilding segment has definitely been a case of two sectors—the luxury sector, which is doing extremely well, and the first-time homebuyer sector, which is getting bombarded from increasing real estate prices, increasing interest rates, and a lousy job market.

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We’re starting to see mergers and acquisitions (M&A) activity in the homebuilding space, with two deals. First, Tri Pointe Homes (TPH) is buying Weyerhaeuser’s homebuilding unit, and second, Toll Brothers is buying Shapell. We can attribute much of this to the two-tiered financing market in general. Large companies like those in the homebuilder ETF (XHB) are able to borrow at exceptionally low interest rates and almost have money thrown at them by the Street. Smaller builders, however, are stuck dealing with the banks, and credit is much tighter for them.

Implications for mortgage REITs

Mortgage REITs, like Annaly (NLY) and American Capital (AGNC), are driven by interest rates. The mortgage REITs have been crushed as the ten-year bond has sold off, but they’ve been trying to form a bottom here. For REITs, it’s all about the Fed’s exit of QE (quantitative easing). In his post-FOMC press conference, Ben Bernanke told the market to expect a reduction in pretty much every FOMC meeting, with the normal caveats that everything is data-dependent.

Implications for homebuilders

Homebuilders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF) are more sensitive to general economic strength. Both Pulte and D.R. Horton noted that the spring selling season seems to have started early this year, which bodes well for 2014 earnings for the whole sector.

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