The prospect of rising interest rates has taken a hefty toll on Home Depot (NYSE:HD) and Lowe’s (NYSE:LOW). Both stocks are down more than 8% this year, while the Dow Jones Industrial Average lost just over 2%.

The drop comes after a powerful rally last year, fueled by the housing market boom and low-interest rates—two catalysts that lured Americans to spend more on their homes. However, the fast-changing macro-environment suggests that this rally has already peaked, and there is more short-term weakness on the way.

Since reaching its 52-week high in late December last year, Atlanta, Georgia-based Home Depot fell 13.3%. The stock closed Wednesday at $364.37.

Home Depot Weekly Chart

Similarly, Mooresville, North Carolina-based Lowe’s peaked in December last year but since then lost 11% of its market cap, closing at $233.66 yesterday.

Lowe's Weekly Chart

The biggest threat to housing-linked stocks comes from the Fed and whether it will aggressively hike interest rates to fight inflation. If that happens, it will hurt demand for single-family homes, one of the main drivers of demand for home improvement during the pandemic.

Signs that conditions for the housing market are changing are beginning to mount. The University of Michigan’s buying condition index fell from 143 in January 2020 to 63 in November. In addition, the pandemic-triggered rush from small urban apartments to more spacious single-family houses in the suburbs may have peaked as both schools and offices reopen.

Moreover, although Home Depot and Lowe’s vastly exceeded analysts’ expectations in their most recent earnings, growth is slowing. Between April 2020 and April 2021, HD recorded four straight quarters of double-digit same-store sales growth. But in the third quarter, that rate of expansion was 6.1%. Lowe’s recorded a 2.6% expansion.

Dividend Appeal

There is no doubt that the major upward move in Home Depot and Lowe’s is over in the current cycle. However, we continue to recommend both stocks to long-term income-seeking investors who want to take advantage of recent weaknesses.

Both companies are well-positioned to weather the current inflationary environment and have a solid track record of consistent dividend payouts.

HD currently pays a $1.65 quarterly share dividend, which has grown, on average, 22% each year during the past five years. That kind of escalation will likely continue. The company has a sustainable, low, 43% payout ratio, leaving plenty of room for the retailer to distribute more cash to shareholders.

Lowe’s has also been growing its payouts regularly, exceeding the inflation rate. The company currently pays an $0.80 quarterly share dividend which translates to a 1.2% annual yield. Lowe’s average dividend per share growth rate has been about 17% during the past five years.

Truist Securities, while upgrading HD to buy from hold, said in a note that the long-term outlook is still strong. Its note adds:

“We expect key industry drivers including supply/demand imbalances in the housing market, pandemic-driven behavioral changes, and aging housing infrastructure to drive significant incremental home improvement growth. Further, we believe that Home Depot will continue to gain share from its size/scale benefits and enhanced supply chain capabilities. We are buyers of HD shares.”

UBS also reiterated its buy for both HD and LOW in a note this week saying:

“Our checks indicate that home Improvement trends remained solid in 4Q and HD/LOW again capitalized nicely on the backdrop. Thus, the companies stand well-positioned to deliver top-line growth and margin expansion.”

Bottom Line

Investors focused on capital gains shouldn’t expect significant price appreciation in HD and LOW this year as the low-interest-rate cycle winds down and the housing market braces for a slowdown.

However, both names could provide a good entry point to long-term, income-focused investors who are focused on earning growing dividends.