Calling a financial stock a “cyclical” may seem like a misuse of terms at first glance. The term generally refers to companies that are highly sensitive to the economy, and it historically conjures up images of smokestack industries like steel and autos. During good times they make a lot of money, and during recessions they tend to lose a lot. As a result these companies tend to have extremely low price-to-earnings ratios during booms and large price-to-earnings ratios during recessions. How would this logic apply to a mortgage banker like UWM Holdings (NYSE: UWMC)?
Mortgage banking is a highly cyclical business, but it isn’t tied to the economy the way an industrial like Ford Motors or 3M is. Mortgage banking tends to do well in the middle of recessions because the Federal Reserve has usually cut rates to support the economy by then. The big drop in rates makes it profitable for homeowners to refinance their loans, which generates activity for the mortgage bank. Real estate in general is an early-stage performer; note that housing starts spike almost immediately after a recession, with the exception of 2009. It is important to remember where we are in the cycle. The economy is in an early stage of recovery, which means good things for industrials. That also means that the best part of the cycle is in the rearview mirror for mortgage banks, which is why those stocks are struggling.