Ride Out the Construction Boom with Housing ETFs

Being stalled by frigid weather conditions and declining demand for homes in the first half of the year, the housing market seems back on track. This is primarily thanks to firming home prices, rising demand, lower mortgage rates, strong job growth, rising wage and increase in housing inventory.

Solid Data Fuels Growth

Though tight lending conditions and limited availability of land and workers are still weighing upon the housing market recovery, there are a number of reasons to be optimistic going forward. This is particularly true when looking at some of the recent housing data that point to a much healthier growth outlook (read: Time to Worry about Homebuilder ETFs?).

Homebuilder confidence, as indicated by the National Association of Home Builders/Wells Fargo housing market index, rose to 55 in August from 53 in July while housing starts climbed 16% in July snapping two months of decline. Both numbers represent the highest growth in seven months, suggesting renewed strength in the housing market.

Recent existing home sales hit the highest level since last September, rising 2.4% to a seasonally adjusted annual rate of 5.15 million. Though new home sales dipped 2.4% for the second consecutive month in July and were below market expectation, it improved 12.3% from last year. On the other hand, distressed homes (foreclosures and short sales) dropped to a single digit for the first time since National Association of Realtors started tracking the category in October 2008. These accounted for 9% of sales in July, down from 15% last year.

Total new home inventory at the end of July increased 4.1% to 205,000 units, representing a supply of 6 months compared to 5.6 months in June and the highest level since October 2011. This suggests an improving supply picture and firming home prices across the space. In fact, the median home price increased 4.9% year over year in July, down from 13.1% gain last year.

Another report from the S&P/Case-Shiller home price data for June also showed a persistent slowdown in price increases. The year-over-year reading for the 20-city index showed price increases of 8.1%, well below the 9.3% increase in the year-ago month. Each of the 20 cities saw annual price growth slowdown for the first time since early 2008 (read: A Comprehensive Guide to Housing ETFs).

The rising inventory and modest home prices are expected to encourage buyers to purchase more homes. This might propel the homebuilder stocks higher in the weeks ahead as demand for homes rise. Meanwhile, mortgage rates plunged in recent weeks and are currently at the lowest levels of 2014 though building permits, a gauge of future construction, rose 8.1% last month. An improving labor market and rising consumer confidence are also adding bullishness into the sector.

How to Play

Clearly, the housing sector is performing well in recent weeks and outpacing the broad markets by a wide margin. A broad look at the space could help in erasing some company specific risks, and reduce volatility. In order to do this, investors currently have three ETF options, which we have highlighted in detail below.

All the three products have a decent Zacks ETF Rank of 3 or ‘Hold’ with High risk outlook, suggesting room for further upside (see: all the Materials ETFs here).

SPDR S&P Homebuilders ETF (XHB)

The most popular choice in the homebuilding space, XHB follows the S&P Homebuilders Select Industry Index. The fund manages about $1.8 billion in asset base and trades in heavy volume of more than 4.8 million shares. The ETF charges 35 bps in fees per year from investors. In total, the fund holds about 37 securities in its basket with none accounting for more than 3.61%.

The product focuses more on small cap securities with 51% share, followed by 42% in mid caps. From a sector look, homebuilding and building products make up for nearly 54% of assets, while home furnishing retail, and home furnishing account for double-digit exposure each. XHB gained 4.7% over the trailing one-month period.

iShares U.S. Home Construction ETF (ITB)

This fund provides a pure play to the home construction sector by tracking the Dow Jones US Select Home Builders Index. It holds a basket of 37 stocks with largest allocation going to D.R. Horton (DHI), Lennar (LEN) and PulteGroup (PHM) with over 9% share each. About 54% of the portfolio is dominated by mid cap securities while small and large caps take the remainder (read: D.R. Horton's Earnings Miss Leads to Housing ETF Plunge).

Apart from the home construction sector, building materials & fixtures as well as home improvement retailers also occupy double-digit exposure. The product is rich with AUM of more than $1.5 billion and average daily volume of about 3.8 million shares. The ETF added about 5% over the past month.

PowerShares Dynamic Building & Construction Fund (PKB)

This product follows the Dynamic Building & Construction Intellidex Index, holding 30 stocks in its basket. The fund has managed assets worth $120.7 million while sees light volume of around 33,000 shares per day on average. Expense ratio came in at 0.63%. The product is slightly concentrated on the top 10 firms at 47.8% of total assets.

Here, the ETF is tilted toward small caps, which make for more than half of the portfolio while mid and large caps take the remainder. The top three sectors include engineering and construction (27%), specialty retail (11%) and construction materials (10%). PKB is up 2.8% in the past four weeks.

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