Pictured: An unfinished sub-division in rural Illinois, May 2015.
Springtime is here, and housing construction is booming.
The US Census Bureau’s latest tally for the seasonally-adjusted annualized rate of housing starts in April came in at 1.14 million, up an incredible 20% from the revised March estimate of 944k (sequentially) and up 9% from the April 2014 rate (year-over-year). That’s some nice expansion, to say the least.
Our long-held indirect plays on the US housing recovery have been a couple of ETFs, which focus on an improving consumer credit environment and incremental loan growth from the depths of the Financial Crisis. The two ETFs can be found in the Best Ideas Newsletter portfolio, and we continue to believe that they are the best indirect way to play improving housing strength in the States. These two ETFs are the Financial Select SPDR (XLF) and the SPDR S&P Bank ETF (KBE).
Our overall views on seeking direct exposure to the US housing market is best summed up in our ETF report that covers the Consumer Discretionary sector, which can be downloaded . We encourage readers to download that piece, and read it. There’s a lot of context behind our views on US housing and the builders, in general. Our biggest concern—and this is not a new one—is that the best period of economic growth in this decade may be behind them. Though we will see fits and starts (e.g. housing starts in April), we’re entering into a period of contractionary monetary policy and slower economic growth. That just doesn’t bode well for direct housing plays, in our view.
But for investors seeking such exposure, there are a couple diversified options.
Within our coverage, two consumer discretionary ETFs have a focus on construction and homebuilding, the SPDR S&P Homebuilders ETF (XHB) and the iShares U.S. Home Construction ETF (ITB). State Street’s XHB is a more varied play on the drivers of the US housing market and is not as tied to the fundamentals of the homebuilders themselves, unlike that of the ITB. Out of the top 10 holdings of the XHB, for example, only four are homebuilders, weighted collectively at ~15% of the fund. The XHB may be the best ETF to consider for investors seeking diversified exposure to housing-related companies, in general. However, for investors pursuing diversified and direct exposure to the homebuilders, the ITB may be the most relevant option for them. For example, the top 5 holdings in the ITB, which are all homebuilders–Lennar (LEN), DR Horton (DHI), PulteGroup (PHM), Toll Brothers (TOL) and NVR (NVR)—account for over 40% of fund assets.
Though investors may consider dabbling in the builders to capture the latest fumes of this bull market, we’re not very enthused by the home improvement retailers—Home Depot (HD) and Lowe’s (LOW)—even as we say we very much like their economic returns and long-term growth prospects. As with any investment, the return to the investor is principally based on the price paid for the asset (stock), and even strong companies can turn into poor investments if initiated at the wrong price. This is the problem challenging a new investment in the home-improvement retailers at the moment.
Home Depot is delivering strong comparable store sales growth, as it did during its fiscal first-quarter results, but the cyclical nature of the housing market is undeniable. As with many consumer discretionary entities, the market is pricing Home Depot as if it is a secular growth story tied to steadily-growing (or stable) end markets. The housing bust of the last decade showed us that this just isn’t the case. Home Depot and rival Lowe’s are two of the most overvalued stocks on the market today. We’re not happy to say so, but their valuations are stretched, unfortunately.
Our US housing exposure continues to be indirect and tied to diversified securities levered to improving consumer credit and incremental loan growth. The aforementioned financials ETFs fit the bill.