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ETF’s dirty little secret

Lawrence Lewitinn
Talking Numbers
ETF’s dirty little secret

You can’t judge a book by its cover, goes the adage. It seems you can’t judge an ETF by its name, either.

You can’t judge a book by its cover, goes the adage. It seems you can’t judge an ETF by its name, either.

Take for instance the SPDR S&P Homebuilders ETF (the XHB). Most would assume it is comprised of homebuilders, as its name implies. But a look under the hood reveals a starkly different picture that investors need to know about.

(Related: Home prices rise most since 2006, pace cools: S&P/Case-Shiller)

While the XHB is up nearly 12% in 2013, many of the nation’s largest homebuilders actually down over the same period of time.

DR Horton 0%
PulteGroup -11%
Lennar -14%
NVR -3%
KB Home +7%
Hovnanian -25%
Ryland +5%
Beazer 0%
Meritage +19%

So, what gives?

“When we look at the XHB, it’s the ‘S&P Homebuilders Index’ – somewhat a misnomer,” says Talking Numbers contributor Richard Ross, Global Technical Strategist at Auerbach Grayson. “Those homebuilders comprise really a small minority of the index.”

If homebuilders are down, then what's propelling the performance of the XHB?

“If you’re going to buy an ETF that has a name,” says Talking Numbers host Brian Sullivan, “dig into what’s actually in the name.”

Companies like Home Depot and Lowe’s which after huge rallies now carry disproportionate weight in the ETF. But those stocks speak more to the recovery in existing homes than they do to new home construction.

(Related: Copper theft 'like an epidemic' sweeping US)

“I think it’s important to point out that there’s a major dichotomy among the existing home sales and the new home sales,” says Talking Number contributor Enis Taner, Global Macro Editor at RiskReversal.com. “If we look at existing home sales, that’s really what’s driven the recovery over the last five years. In fact, existing home sales are at mid-2007 levels. They’ve driven the overall move in house prices and house sales.”

“On the other hand, new home sales – which are where the construction industry and the homebuilders really benefit – have been very stagnant,” says Taner. “It’s less than half the level it was at the peak in 2005 and it’s only at mid-2008 levels now.”

In other words, the housing recovery may not be as strong as the XHB's performance suggests, and investors should watch the video above to hear about the ETF’s dirty little secret.