Will the housing market crash again? Maybe. Many aspects of the economy are cyclical, and housing prices do occasionally fall. Is a housing crash imminent? That's harder to answer.
Some have sounded the alarm on housing for good reason. Consider the famous Case-Shiller Home Price Index, an inflation-adjusted metric created by Standard & Poor's tracking housing prices. The index's value was 100 back in the year 2000 and had been close to 100 when applying the index's criteria backward to the 20th century. But since 2000, it has risen above 180 on two occasions. The first time preceded the housing crash of the Great Recession.
The second time the Case-Shiller index exceeded 180 is right now. In reality, it passed the mark way back in 2016, and it's currently around 215. So no need to panic: Crossing 180 doesn't immediately flip a housing-crash switch. It just shows housing prices have gone up a lot. The bigger problem, though, is how much faster home values are growing relative to average income. Consider the data over just the last 10 years.
It's probably unsustainable for home values to outpace personal income long term. Eventually people could be priced out of affordable housing, and that could spark a housing market correction. Will that affect companies like Home Depot (HD -2.41%)?
To answer that, we can start by going back to the Great Recession.
The last time Home Depot's revenue fell
Home Depot's revenue fell from 2007 to 2009. In fiscal 2006, when things were going well, the company generated $90.8 billion in full-year net sales. In fiscal 2009, it generated just $66.2 billion -- down 27% over three years. Likewise, net earnings took a hit as the company lost operating leverage from lower sales per location. Net earnings fell a whopping 55% from $5.8 billion in 2006 to $2.6 billion in 2009.
The Case-Shiller index fell 20% from the beginning of 2007 to the end of 2009, and it's tempting to attribute Home Depot's slumping results entirely to plunging home values. Results from Lowe's (LOW -4.03%) lend credibility to this theory. In fiscal 2007, Lowe's sales at existing stores, known as comparable sales, fell 5.1%. This is similar to Home Depot's 6.7% comps decline that same year.
But this is correlation, not causation. Consider that home values were already going down in 2006 when Home Depot's sales were still up. Furthermore, the Case-Shiller index fell another 7% from the beginning of 2010 through the end of 2011. By contrast, both Home Depot and Lowe's had already returned to revenue growth.
To summarize, home values and revenue for home-improvement retail don't always track in the same direction. And that makes sense. Regular home maintenance doesn't stop just because the value of a home drops.
The greater risk
There were multiple other issues affecting Home Depot's revenue in the Great Recession, including high unemployment, lack of credit, and a construction slowdown. But that last factor is a big deal. In fiscal 2006, the company estimated that 30% of retail sales came from professional customers. As construction slowed, so did Home Depot's revenue. By contrast, Lowe's professional customers made up a smaller percentage of sales, and as a result, its revenue drop wasn't as sharp.
In the third quarter of fiscal 2019, Home Depot management informed investors that pro sales now account for 45% of the top line. This means a slowdown in construction would be even worse for the company now than it was then. And since Lowe's has also been focused on expanding its percentage of pro customers, it would feel the greater impact as well. The same could be said of Sherwin-Williams (SHW -1.61%), which has a large customer base of professional painters.
Fortunately for these three companies, construction isn't slowing right now. According to the U.S. Census Bureau, construction started on 127,300 new privately-owned housing units in August, up 5% year over year. Excluding strong numbers in July, this is the highest number of starts in over a decade. And there are over 1.2 million homes under construction right now -- the most since Nov. 2006.
When it comes to home-improvement retail, construction data points to continued strong sales. Investors worried about a potential pullback in home values should take this into consideration. Right now, the outlook is sunny.
But what if?
Investors should keep one more thing in mind. Even if a housing crash or a combination of factors comes along to drag down Home Depot stock near term, one must stay focused on the long-term story when investing in stocks. For example, if you timed things perfectly in 2006 and sold before the housing crash, you would have missed out on one of the greatest decades ever for home-improvement retail stocks.
Home Depot, Lowe's, and Sherwin-Williams stocks were under pressure, yes, but holding or even buying these top companies during hard times and reinvesting dividends over the long haul paid off big time, as the above chart demonstrates. Selling because of the impending market crash would have been a mistake then.
In the long run, investors would have lost far more money by selling Home Depot stock too early. The same is probably true now. We don't know when a housing-market crash will happen. And we don't know how hard it will be or how long it will last. Better than taking wild guesses about these things, investors should calmly look to buy stock in top companies and be prepared to hold for the long term.