Are Housing ETFs in Trouble?

The housing sector held up quite well for most of 2013, but concerns have started to build of late on bad weather conditions and Fed tapering plans. As the Fed discussed curtailing its stimulus, interest rates moved up leading to a rise in mortgage rates.

While mortgage rates have since stabilized, home prices have continued to move higher, and these are keeping most homebuyers away from the market. Additionally, a harsh winter has taken a toll on homebuilders resulting in lower demand as depicted by the string of weak data that raises the question on the strength of the housing market.

Weak Data

Homebuilder confidence, as indicated by the National Association of Home Builders/Wells Fargo housing market index, dropped to 46 in February from 56 in January. This represents the lowest level in nine months and a pessimistic outlook for the near term (read: The Comprehensive Guide to Housing ETFs).

Further, housing starts tumbled 16% to an annualized rate of 880,000 in January buoyed by lower single-family homes and apartments. This marks the biggest drop in almost three years. Building permits, a gauge of future construction, also declined for the third straight month to 5.4% in January.

If this wasn’t enough, existing home sales saw the slowest pace in 18 months in January, declining 5.1% from the last month.

Any Hope?

Once winter passes, the sector will likely gain momentum on an improving economy and healing job market. Home prices also seems to be leveling off on rising inventories across the country (read: Homebuilder ETFs Rise on Solid Earnings, Strong Home Prices).

According to the latest data from Zillow, the value of homes in the U.S. was up only 0.2% in January, representing the smallest monthly gain since May 2012. Inventory increased slightly to a 4.9-month supply in January from a 4.6-month supply in December.

Notably, 22 of the 35 largest metro areas have higher inventory with the largest gains coming from Las Vegas (up 42.8%), Phoenix (up 30.5%) and Sacramento (up 26%).

The rising inventory and modest home prices are expected to encourage buyers to purchase more homes in spring and offset the impact of any rise in mortgage rates. This might propel the homebuilder stocks higher in the weeks ahead as demand for homes rise.

Moreover, the Zacks Industry Rank confirms the bullish trend for the space, as homebuilding actually has the best Rank for any industry at the time of writing. All of the five industries classified under homebuilding or construction have Zacks Rank within the top 42%, suggesting smooth trading in the coming months.

Given this, investors seeking to ride out this opportunity could look to the following homebuilder ETFs for exposure (see: all the Industrial 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 $2 billion in assets and trades in heavy volume of more than 4.6 million shares a day. The ETF charges 35 bps in fees per year from investors.

In total, the fund holds about 37 securities in its basket with none holding more than 3.91% of total assets. The product focuses more on mid cap securities with 50% share, followed by 36% in small caps. From a sector look, homebuilding and building products make up for nearly 60% of assets, while home furnishing retail and home furnishing account for double-digit exposure.

XHB lost 1.41% in the year-to-date period and has a decent Zacks ETF Rank of 3 or ‘Hold’ with ‘Medium’ risk outlook.

iShares U.S. Home Construction ETF (ITB)

This fund provides pure play to the home construction sector by tracking the Dow Jones US Select Home Builders Index. It holds a small basket of 34 stocks and is heavily concentrated on the top 10 holdings with over 63% of total assets with the double-digit allocations going to Lennar (LEN), PulteGroup (PHM) and D.R. Horton (DHI).

The fund is skewed toward mid cap securities (59%), followed by small cap (29%), and charges 45 bps in fees and expenses. Apart from the home construction sector, building materials & fixtures as well as home improvement retailers also account for double-digit levels of exposure. The product is rich with AUM of nearly $1.7 billion and average daily volume of more than 5.2 million shares.

The ETF added about 2% so far this year and has a Zacks ETF Rank of 2 or ‘Buy’ rating with ‘Medium’ risk outlook (read: 3 Sector ETFs Benefiting from Plunging Interest Rates).

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 $109.4 million while it sees light volume, and the expense ratio comes in at 0.63%. The product is little bit concentrated on the top 10 firms at under 47% of total assets.

Here again, the ETF is tilted toward mid caps which make half of the portfolio while small and large caps take the remainder. The top three sectors include engineering and construction (22%), construction materials (16%) and specialty retail (13%).

PKB is up about 0.5% year-to-date and has a decent Zacks ETF Rank of 3 or ‘Hold’ with ‘Medium’ risk outlook.

Bottom Line

Though the sector is not performing as expected, it will likely show some strength in the near term given a rising inventory and affordable home prices. Further, the demand for homes would rise in the spring season, which is just a few weeks away (read: 3 Rate Sensitive Sector ETFs Still Going Strong).

As such, investors should start preparing for this surge and focus on the sector with the abovementioned ETFs.

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