market watch | Feb 7, 2018 |
As interest rates rise, home stocks get hit hard

Last week, shares of home stocks, including Restoration Hardware, Williams Sonoma and Ethan Allen, all fell, some by nearly 11 percent (compared to the 4 percent Dow Jones decline). In this week’s Market Watch column, Dennis Scully breaks down what this steep drop means for the home furnishings industry.

At 8:30 a.m. last Friday, jittery stock traders were glued to their Bloomberg terminals, waiting for the Labor Department to release its monthly unemployment numbers. They were keenly focused on how the bond market would react to the news.

The bond market has been giving traders a reason to worry since the New Year began. Suspicious that the constant flow of good economic news coming from both corporate America and Washington, D.C., would soon cause inflation to rise, bond traders have been driving up interest rates relentlessly since the start of 2018. Stock traders knew that a strong employment number would likely cause rates to rise even further.

As interest rates rise, home stocks get hit hardMore importantly for the home industry is that the 10-year yield is used most often to calculate mortgage rates. With the start of the spring home-selling season just weeks away, it couldn’t be a worse time for mortgage rates to be on the rise.

Sure enough, the labor report came in stronger than expected: 200,000 new jobs were created in January and the unemployment rate remained steady at 4.1 percent, a 17-year low. Most importantly, the number that traders had been watching closely—average hourly wages—rose 2.9 percent for the month. That’s the biggest jump in wages in eight years.

Stock traders wasted no time. Selling stock market futures, they drove the market down 200 points in pre-opening trading. The day would soon get far worse, and by the time it was over, the longest uninterrupted winning streak in the stock market’s history had come to an end. Never before has a stock market advance like the one we’ve experienced since Election Day 2016 gone on for this long without stocks eventually pulling back in a meaningful way.

By 4 p.m. Friday, as the closing bell on Wall Street mercifully rang out to mark the end of trading for the day, the Dow Jones Industrial average had lost over 1,000 points for the week, a drop of more than 4 percent.

The yield on the 10-year Treasury (a 10-year bond issued by the federal government to fund its operations) had steadily climbed to its highest level in more than three years. The significance of this move clearly had traders rattled, as they tried to determine what it will ultimately mean for the economy.

Ten-year Treasury bond yields are often seen as a canary in a coal mine, sounding out a warning that the economy is getting overheated and that it is time for the Federal Reserve to step in and raise interest rates to cool things down.

More importantly for the home industry is that the 10-year yield is used most often to calculate mortgage rates. With the start of the spring home-selling season just weeks away, it couldn’t be a worse time for mortgage rates to be on the rise.

With the increasing popularity of home staging, interior designers and furniture manufacturers alike have been benefiting recently from the home seller’s market as well as from home buyers. Higher rates could put a damper on home sales in the short term, causing a slowdown in this part of the market.

As mortgage rates climbed well above 4 percent last week, homebuilder and furniture company shares fell hard. Shares of Lennar Corp. and Toll Brothers, two of the nation’s largest builders, fell by more than 11 percent and 6 percent, respectively. RH, the parent company of Restoration Hardware and Waterworks, also fell more than 11 percent on the week. Williams Sonoma, parent company of Pottery Barn and West Elm, saw its shares fall by more than 7 percent. Ethan Allen shares fell by 6 percent on the week.

While the stock market’s recent sharp reversal seemed to catch many by surprise, it was long overdue. Historically, markets experience at least a 3 percent correction six times a year, on average, so what we have seen in the past 14 months was by no means normal. Interest rates have also been artificially low for many years, in an effort to help our economy to recover. That recovery, which has been in place now for years, has clearly accelerated in recent months.

Now the economy and its recovery will be tested by interest rates returning to more historically normal levels. Consumers stand ready for this, and as we pointed out recently, are now more confident and more financially liquid than they have been at any time since the start of the Great Recession. Stock market volatility is returning, rightfully, after an extended absence—and that’s a good thing. Healthy corrections remove excesses from the market and remind us all not to become too complacent as we manage our investments and our businesses.

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