Investors were enthused earlier this week by some strong housing data. New home sales jumped 12.4 percent in July to a seasonally adjusted rate of 654,000 annual units, well ahead of economists' estimate of 580,000 units.
Although the June number was revised lower to 582,000 from 592,000, the July report was enough to send homebuilders stocks and exchange-traded funds, such as the SPDR S&P Homebuilders (ETF) (NYSE: XHB) and the iShares Dow Jones US Home Const. (ETF) (NYSE: ITB) soaring.
Simplicity Is Not Always The Best Policy
However, investors should be careful before considering CUT and WOOD to be adequate proxies for ITB, XHB or individual homebuilders shares. For starters, the advice is simply too, well, simple. Buying timber ETFs because wood is used in home construction seems like a good idea — in theory.
In reality, the advice is only marginally better than buying consumer discretionary stocks because its holiday shopping season (the best month periods of performance for the benchmark consumer discretionary ETF are in the first and third quarters, not the fourth) or buying healthcare stocks and ETFs because a Democrat is leading a presidential poll. Just check out biotech ETFs to confirm how bad that advice is.
Second, ITB and XHB, the homebuilders, are essentially entirely allocated to U.S. stocks. The same cannot be said of timber ETFs. For example, WOOD allocates just 44.3 percent of its weight to U.S. stocks. Additionally, it is a stretch to assume an ETF that allocates almost 23 percent of its weight to Japanese and Finnish stocks is adequately levered to U.S. home sales trends.
Why XHB, Peers?
XHB differs from rival homebuilders ETFs due to its robust exposure to the discretionary/retail side of the residential real estate industry. That includes an almost 8 percent weight to home improvement retailers, a group expected to deliver some of the most impressive earnings growth in the broader consumer discretionary sector.
Then there are correlations, which really tell the tale of the tape. XHB has a five-year correlation of 0.765 to both CUT and WOOD. Not weak, but not really that strong, either. The situation is worse with ITB, which is telling because ITB is more of a pure-play homebuilders fund than XHB. ITB's five-year correlations to CUT and WOOD are 0.697 and 0.706, respectively, according to State Street data.
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