An analyst who called a grim start for homebuilding stocks this year as well as their rebound in recent months is confident that the group will stay strong in 2023.

The sector should fare better than the S&P 500 Index next year, according to Kenneth Zener at Keybanc Capital Markets. The group fell harder than the overall market earlier this year, so based on a historical review of their performance going back to the 1960s, the analyst expects homebuilders to recover first. Zener has been positive on homebuilders since September, after warning in January that the stocks faced a "wall of worry."

"I have never been more optimistic that homebuilders will outperform the market on a relative basis," he said in an interview. Zener is the top-ranked analyst on Wall Street based on absolute returns for at least four of the builders he covers over the past year, including industry giants D.R. Horton Inc. and Lennar Corp., according to data compiled by Bloomberg.

Zener compared homebuilders to the broader market in recent decades. His grim outlook in January reflected how the stocks performed in Federal Reserve tightening periods, while his bullish pivot in September was due to the timing of the group's stock performance relative to the S&P 500.

"Early pain" equals "early gain," he wrote in his September note, highlighting that builders typically rebound ahead of the rest of the market.

The S&P Supercomposite Homebuilding Index fell 27% from January through Zener's September call, while the S&P 500 dropped about 15%. Since his pivot, builders have risen about 17% while the broader market is lower by about 1%.

"Our positive sector call is not necessarily an absolute call on the stocks, but their relative performance to the S&P," Zener said.

Interest-rate hikes this year have slammed homebuilder stocks as they emerged from the supply-constrained pandemic era, eroding demand for homes and pressuring orders and builders' margins, sending shares plunging to the lowest level since 2020 in June. How much falling home prices and rising rates have been priced into stocks has been a key question for industry watchers.

Zener is not the only analyst seeing strength. Earlier this month, Matthew Bouley at Barclays turned positive on the group, writing in a note that the "time is now for builders."

Heading into 2023, Zener's favorite names in the group are builders with higher returns on their inventory, such as Lennar, NVR Inc., D.R. Horton and Meritage Homes Corp.

"We think investing in high return on inventory builders will generate better risk-adjusted stock returns," Zener wrote in his September note.

Lennar sparked a rally in the group earlier this month after saying its cancellation rate peaked in October and that it expects gross margins to reach their lowest point of the year in the first quarter of 2023. Investors will be closely watching earnings results and commentary from D.R. Horton come late January.

Bre Bradham and Norah Mulinda report for Bloomberg News.

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