Here's What Chopped Down the Lumber Market – And Here's When It Will Bounce Back
Most of us have heard the phrase “If a tree falls in a forest, and there's no one there to hear it, does it make a sound?”
It's an exercise in critical thinking that's been around since the early 1700s. Engineers tackle it one way, and philosophers come at it from a wholly different direction.
There's no simple “yes or no” answer.
When you're talking about the entire timber market, however, it's a completely different animal. When that market crashes to the ground, it absolutely makes a sound — a big one that's heard and felt by investors, consumers, companies, and a broad array of industries.
We've had just such a crash — since peaking in March, lumber futures were down more than 70% near the end of September — and that has folks scrambling for answers.
In this issue of TradeSmith Daily, we're going to bring you those answers — and show you why this happened.
But we'll also detail what comes next and spotlight some moneymaking plays the “experts” have yet to identify.
You can't restore a tree that's already fallen. But you can plant new ones. And markets that have crashed can rebound.
Here's the timber-crash tale, our forecast for the lumber market, and some timber-related stocks to consider carefully.
In the summer of 2020, lumber prices tripled, thanks to Americans whose lockdown stir-craziness prompted them to see their houses as more than just a place to sleep at night.
The American home became a center for entertainment, for “staycationing,” for exercising — and, thanks to the new remote work revolution, for working.
Consumers decided to upgrade, either by remodeling their existing homes or by shopping for something bigger, better, and ideally located.
But booms, or bubbles — label them however you wish — have shared one common feature throughout history.
They end.
Like the tree in the forest when there IS someone there to hear it, they crash to the ground — loudly, causing a considerable amount of damage.
That was certainly true of the U.S. lumber market.
From their March 2022 apex above $1,460 per thousand board feet for random-length wood, futures toppled to around $509 recently, according to research by Trading Economics.
Demand collapsed — leaving lumberyards and your local Home Depot Inc. (HD) overstocked with wood, sending prices back to pre-pandemic levels — thanks to three key catalysts.
3 Reasons the Lumber Market Went “Timber”
Reason No. 1: Booms Are Unsustainable
Booms are temporary, usually in response to a triggering event.
They may also be seasonal, like the bump we see in retail sales during the holiday shopping season.
With lumber, the trigger was the COVID-19 pandemic. Illness-related absenteeism created labor shortages in the lumber supply chain and revved up other supply-chain disruptions.
The spike in demand, thanks to the remodeling and homebuilding booms, ignited a 300% jump in the U.S. price of softwood lumber.
But to employ another popular saying, what goes up must come down — because market conditions are constantly shifting.
And down lumber prices came.
The hoarding we saw from lumber buyers who didn't want to be caught short on supply — who feared the high prices of today would give way to even higher prices tomorrow — finally ended as supply and demand finally returned to equilibrium. Random Lengths, a wood-pricing service with a framing-lumber composite index, says cash sales have plummeted more than 60% since March.
As we said at the outset, this is one crash whose sound has echoed throughout the market.
Take the iShares Global Timber & Forestry ETF (WOOD), which surged 147% from the March 2020 crash to its May 21, 2021, peak.
But WOOD is down nearly 20% since the beginning of this year.
Fourteen of its 18 holdings are in the unhealthy Red Zone; only three are in the Green Zone, and one doesn't yet have a Health Indicator zone.
Reason No. 2: A Paul Bunyan Central Banker
If there was an initial hack at the lumber market's trunk, it was a U.S. Federal Reserve that was hell-bent on beating inflation, using the sharpest blade at its disposal: higher interest rates.
The Fed has raised rates six times this year, adding a full 75-basis-point (three-quarter percentage point) increase at each of the past four Federal Open Market Committee meetings.
Boosting the benchmark federal funds rate cools economic growth. Borrowing costs increase, slowing demand. And those Fed moves cascade through the economy, since higher borrowing costs include higher mortgage rates. The average rate for a 30-year fixed-rate mortgage stood at 7.22% on Nov. 1.
Higher mortgage rates freeze out homebuyers, who either can't qualify for the higher rates or fear the crush of high monthly payments.
Fewer homebuyers means lower demand. And lower demand brings us to…
Reason No. 3: New Home Builds Are Down
Wood is pervasive in home construction; it's used for much more than just framing the house.
Every square foot of a house requires 6.3 board feet (a unit of measurement equal to a 144-cubic-inch piece of wood). In a small house of about 1,000 square feet, for instance, that works out to about 6,300 board feet.
In the average house — about 2,000 square feet in size — you're talking about 12,600 square feet. Roughly 30% of your home is made from lumber.
When demand for new housing construction cools, a lot of wood sits in lumber yards.
One early warning signal for housing-market trouble is a surge in new-home-construction cancellations.
D.R. Horton Inc. (DHI), America's largest homebuilder, said roughly 24% of new home orders were scrapped in April and June. And the real estate consultancy firm Zonda reported that roughly 87% of builders are planning to slow down production in response to slowing demand.
Shares of lumber-related companies took the hit — proving this was one crash whose sound was heard… resoundingly.
Although demand has dropped for lumber used in housing renovation and new construction, the fact is that other products are made from wood too, such as paper towels and copy paper. One of the few Green Zone holdings in the aforementioned iShares Timber & Forestry ETF is Sylvamo Corp. (SLVM), a paper products company.
Memphis-based Sylvamo operates paper mills that produce printer and copy paper under the popular brands Hammermill and HP Papers.
As long as demand for that kind of paper doesn't stumble, the fall we've seen in lumber prices actually works in Sylvamo's favor. Its input costs should be lower, which should improve operating margins and ultimately the bottom line.
On that point, fourth-quarter guidance calls for volume improvements of $10 million to $15 million due to strong demand from Europe, North America, and Latin America.
SLVM triggered an Entry Signal on Oct. 24, is currently in an uptrend, and has a high-risk Volatility Quotient (VQ) of 42.81%.
As opposed to the diversified and potentially overexposed WOOD, SLVM could be a standout player on its own.
That's a pretty good intermediate-term outlook.
Let's also look out a bit further at the lumber-intensive housing market.
If the Fed's battle against inflation is successful — meaning it blunts the surge in prices without blunting U.S. economic growth — the American housing market could reignite in the latter part of next year.
“Lumber prices lead economic activity in housing a year in advance,” Shawn Hackett, president of commodities researcher Hackett Financial Advisors, wrote in a recent research note. “We are optimistic that the U.S. economy will be improving by late 2023 which means that lumber prices should be placing an important low now.”
If that happens, lumber demand will begin to surge.
Then there's the supply question.
Russia and its ally Belarus account for a combined 12.2% of global exports of lumber, Forbes writer Simon Constable reported recently. With Russia's ongoing military campaign against Ukraine – not to mention the sanctions the West has imposed on Russia and its allies — lumber supplies could be squeezed globally, and for some time to come, according to Constable.
The bottom line: Boosted demand from a stronger housing market next year coupled with tighter global supplies could mean that the bottom in lumber prices has been set, with higher prices to come.
Think of the additional timber-related profit opportunities that will bring.
And know that, here at TradeSmith, we'll continue to explore them here for you.
Take care,
Team TradeSmith
P.S. Unfortunately, there's no time machine for you to go back and invest in the lumber industry before its last bull run.
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TradeSmith is not registered as an investment adviser and operates under the publishers' exemption of the Investment Advisers Act of 1940. The investments and strategies discussed in TradeSmith's content do not constitute personalized investment advice. Any trading or investment decisions you take are in reliance on your own analysis and judgment and not in reliance on TradeSmith. There are risks inherent in investing and past investment performance is not indicative of future results.
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