Stocks are treading water as earnings fall to the Dow Jones

Homebuilder stocks have been one of the brightest spots in the market's rise, but Tuesday's news shows the sector remains sensitive to interest rates and their impact on the housing market.

DR Horton (DHI) shares fell 9% at midday Tuesday after the homebuilder reported weaker-than-expected quarterly orders and reported first-quarter earnings per share that beat analysts' estimates. Investor reaction also sent the SPDR S&P Homebuilders ETF (XHB) down as much as 3%.

Both XHB and DR Horton closed at record levels on Monday.

Specifically, D.R. Horton said in his call with analysts that he would be cautious in making changes to his franchise strategy — which consists of purchases at subprime interest rates that hurt margins but make homes more affordable for buyers — if mortgage rates stall in decline.

“The use of these price buys is not new to us over the past 12 months,” CEO Paul Romanowski said on Tuesday. “We've been using this incentive for over 24 months. So I think that on a going forward basis, we'll still be able to compete not only in the new local market, but particularly in the resale market for us, being able to get a lower monthly return,” he said. The cost of the house is beneficial. “So we have no near-term plan to stop using it even if we see prices fall.”

This comment differs from the one made by KB Home (KBH) earlier this month, which hinted at a decline in incentives for the first quarter of this year.

Mortgage rates fell to a seven-month low last week of 6.6%, down from 6.66% a year earlier and 7% in September.

But long-term interest rates, which fuel mortgage rates, have risen recently as investors become less optimistic about the Federal Reserve's interest rate cuts starting in March.

Despite the weak data from DR Horton, new construction was a major source of housing inventory boost as supply in the resale market fell to its worst level in decades last year. In response, homebuilders across the country have launched attractive incentives to generate interest from buyers and cushion the shock from rising interest rates and home prices.