Shares of Home Depot Inc. and Lowe’s
Cos. — the two largest U.S. home-improvement retailers — are
outperforming other consumer discretionary stocks as the worst
of the declines in the housing market may be over.

Americans are on pace to spend $337.3 billion on their
homes, with annualized private-residential fixed investment
rising 3 percent from 2010 for the three months ended Sept. 30,
Bureau of Economic Analysis data show. This is only the second
such increase since 2006 and unlike 2010, wasn’t boosted by
government tax-credit stimulus programs including one for
appliances, said Scot Ciccarelli, a New York-based analyst at
RBC Capital Markets.

Same-store sales for the two retailers — which track
residential investment — have started to improve and may pick
up even more because “there’s been some industry
stabilization,” said Ciccarelli, who upgraded Home Depot to
“outperform” earlier this month and maintains the same
recommendation on Lowe’s.

Comparable-store sales rose 4.2 percent at Atlanta-based
Home Depot and 0.7 percent at Mooresville, North Carolina-based
Lowe’s in the three months ended Oct. 30 and Oct. 28,
respectively, the companies said earlier this month.

Homeowners likely deferred repair projects for several
years and now are spending on “necessary upkeep” so their
residences remain livable, Ciccarelli said. As a result,
“upside earnings revisions (HD) are more likely,” and shares of
Home Depot and Lowe’s may rally more than the market, he said.

Rising Stocks

The Standard & Poor’s 500 Home Improvement Retail Index,
comprised of the two retailers, hit a peak on Nov. 25, 2008, on
a relative basis and then underperformed the Consumer
Discretionary Select Sector Index by 68 percent through Aug. 10,
2011. Since then, the home-improvement index has risen 36
percent, compared with a 10 percent increase for the consumer-
discretionary index, which includes Macy’s Inc. (M) and Kohl’s Corp. (KSS)

The underperformance was “very severe” amid persistent
negative news about housing, said Michael A. Gayed, chief
investment strategist at Pension Partners LLC. Now, “even a
small amount of positive news is a big surprise” to investors,
which is why these retailers may lead the consumer sector, said
Gayed, whose New York firm oversees $140 million in assets.

While the industry has been “bouncing along a bottom”
this year, there are “solid signs of stabilization” in home
prices and the number of mortgages entering delinquency, said
Russell Price, a senior economist at Ameriprise Financial Inc.
in Detroit.

Slowing Delinquencies

The combined rate of mortgages 30 and 60 days past-due
dropped to 4.5 percent in the quarter ended Sept. 30 after
peaking at a seven-year high of 5.6 percent in 2009, data from
the Mortgage Bankers Association in Washington show. Loans in
delinquency eventually determine the number of foreclosures, so
this suggests a moderating foreclosure rate, which has averaged
4.5 percent since the recession ended in 2009, Price said. From
2005 through 2007, when the recession began, the foreclosure
rate averaged 1.2 percent, according to the bankers association.

Meanwhile, sentiment about home prices is moderating, said
David A. Schick, a retail analyst for Stifel Nicolaus & Co. in
Baltimore, who recommends buying Home Depot and Lowe’s. This is
“potentially a good sign” because people are more likely to
spend if they think their asset is appreciating, he said.

The number of consumers who said home prices are “going
up” dropped 2 percent from a year ago to 15 percent in late
November, according to a survey conducted twice a month by
Stifel Nicolaus. While the difference between this and the 30
percent who reported “falling” prices remained at minus 15
percent — the same as earlier in the month — it was an
improvement from late September’s minus 21 percent reading, the
most negative since April 2009, Schick said.

Smallest Decrease

Residential real-estate prices still are struggling, as the
S&P/Case-Shiller index of property values in 20 cities fell 3.6
percent in September from the same month a year ago, the group
said yesterday. While this was the smallest decrease since
February, it was more than the estimated 3 percent decline in a
Bloomberg News survey.

Lowe’s introduced an advertising campaign in mid-September
– “Never Stop Improving” — to “inspire” customers “to
innovate and improve their homes,” Chairman and Chief Executive
Officer Robert Niblock said on a Nov. 14 conference call.

The company experienced “above average” sales in building
materials, tools and hardware during its fiscal third quarter,
Chief Financial Officer Robert Hull said the same day.

‘Perform Well’

Similarly, Home Depot’s electrical and plumbing sales
outpaced comparable-store results during its third quarter,
Craig Menear, executive vice president of merchandising, said on
a Nov. 15 conference call. “The maintenance and repair
categories that make up the core of our store continued to
perform well,” he said.

Masco Corp. (MAS), a Taylor, Michigan-based maker of Delta
faucets and KraftMaid cabinets, said its third-quarter sales to
“key retail customers,” excluding the impact of exiting some
businesses, “would’ve been up low single digit,” President and
Chief Executive Officer Tim Wadhams said on an Oct. 25
conference call. Sales to these customers — which include Home
Depot and Lowe’s — rose from the prior quarter, indicating
business is improving sequentially, Ciccarelli said.

The outperformance of housing-related stocks may be short-
lived if the economy weakens and interest rates go even lower,
Gayed said. The yield on 10-year government bonds has hovered
around 2 percent since the beginning of November, Bloomberg data
show.

No ‘Meaningful Tailwind’

Another sharp decline in home prices also “would severely
disrupt” recent improvements in residential investment and put
strain on these retailers, he said. Lowe’s has announced it is
closing 27 stores this year, while its competitor doesn’t
“expect to see in the near term any meaningful tailwind from
the housing market,” Home Depot Chairman and Chief Executive
Officer Frank Blake said Nov. 15.

Activity has “remained very weak, held down by the large
overhang of foreclosed and distressed properties, along with
limited demand in an environment of uncertainty about future
home prices,” Federal Reserve policy makers said at their
November meeting, according to the minutes.

There are some signs of life. Sales of previously owned
homes unexpectedly rose 13.5 percent in October from a year ago
to a 4.97 million annual rate, the National Association of
Realtors reported Nov. 21, beating the 4.8 million estimate in a
Bloomberg News survey. This marked the fourth consecutive month
of year-over-year increases, though sales are still 16.9 percent
lower than they were in 2009.

Growing Confidence

Consumer confidence also rose this month by the most since
April 2003, as the Conference Board’s index increased to 56 from
a revised 40.9 reading in October, the New York-based private
research group said yesterday.

Investors are taking a more sanguine outlook on home-
improvement spending as owners have pushed off repair projects
for as long as possible, Gayed said.

Recent government initiatives “could be useful steps
toward stabilizing the housing market,” Fed policy makers said
in November. Expanding the Federal Housing Finance Agency’s Home
Affordable Refinance Program — announced in October — is one
approach that may get this industry “back on its feet,” Price
said.

“Allowing many of the people with high loan-to-value
mortgages to refinance not only increases the likelihood that
they stay in their home, but it also provides them with some
additional monthly savings,” he said.

Even amid a negative macroeconomic backdrop, Americans may
feel more comfortable renovating their homes than spending on
other discretionary items, Ciccarelli said, adding that the
most-recent increase in private-residential fixed investment
suggests “a bottoming process is occurring” in housing.

“We’re seeing the early signs of positive inflection,” he
said. “It’s not big, but it’s still moving up.”

To contact the reporter on this story:
Anna-Louise Jackson in New York at
ajackson36@bloomberg.net

To contact the editor responsible for this story:
Anthony Feld at
afeld2@bloomberg.net