Time to Worry about Homebuilder ETFs?

After a strong rebound last year, the housing sector has been struggling since frigid weather conditions and lower demand for homes raised concerns in the space from the beginning of the year.

Major headwinds such as higher mortgage rates, tight lending conditions for homebuyers, steeper home prices, rising cost of materials as well as limited availability of land and workers have taken toll on the recovery of the housing market (read: Jeff Gundlach Wants You to Short This Sector ETF).

Though homebuilder confidence, as indicated by the National Association of Home Builders/Wells Fargo housing market index, rose slightly to 47 in April from the revised 46 in March, it is well below the expansion level of 50, suggesting fragile conditions for homebuilders.

New home sales dropped 14.5% in March to a seasonally adjusted annual rate of 384,000, representing the lowest level since July. Building permits, a gauge of future construction, also declined for the fourth time in five months by 2.4% while existing home sales were flat. However, housing starts improved 2.8% in March buoyed by growth in single-family homes though the rate was lower than the market expectation.

Apart from macro fundamentals, homebuilder’s have reported disappointing Q1 results, resulting in declining stock prices. Earnings grew 6.4% compared with 13.9% in Q4 while revenues declined 1.4% against a 6.3% rise in Q4 (read: Homebuilder ETFs in Focus on Mixed-Bag Earnings).

Homebuilder ETFs Slumping

Given sluggish fundamentals, homebuilder ETFs have been the biggest laggards in the broad material ETF world and is pushing the space down.

This is especially true as all the three ETFs – SPDR S&P Homebuilders ETF (NYSE:XHB)), iShares DJSU Home Construction (NYSE:ITB) and PowerShares Dynamic Building & Construction Fund  (NYSE:PKB) – are down 7.4%, 6.6% and 4.5%, respectively, in the year-to-date time frame. This compares unfavorably with the gains of about 5.1% for the broad material fund (ARCA:XLB) and 2.8% for the broad market fund (ARCA:SPY) in the same time period (see: all the Materials ETFs here).

SPDR S&P Homebuilders (NYSE:XHB)

This ETF follows the S&P Homebuilders Select Industry Index, charging 35 bps in fees per year from investors. It manages about $1.8 billion in asset base and trades in heavy volume of more than 4.1 million.

In total, the fund holds about 37 securities in its basket with none accounting for more than 3.4% of total assets. The product focuses more on mid cap securities with 49% share, followed by 39% in small caps. From a sector look, building products and homebuilding make up for nearly 55% of assets, while home furnishing retail and home furnishing account for double-digit exposure.

iShares DJSU Home Construction (NYSE:ITB)

This fund provides a pure play to the home construction sector by tracking the Dow Jones US Select Home Builders Index. It holds 34 stocks and is heavily concentrated on the top 5 holdings with largest allocations going to Lennar (NYSE:LEN), D.R. Horton (NYSE:DHI) and PulteGroup (NYSE:PHM) with around 10% share each.

The fund is skewed toward mid cap securities (59%), followed by small cap (30%) while charges 45 bps in fees and expenses. Apart from the home construction sector, building materials & fixtures as well as home improvement retailers also have double-digit exposure. The product is rich with AUM of over $1.5 billion and average daily volume of more than 4.4 million shares (read: 3 Small Cap ETFs Outperforming the Russell 2000 Index).

PowerShares Dynamic Build & Const. (NYSE:PKB)

This product follows the Dynamic Building & Construction Intellidex Index, holding 30 stocks in its basket. The fund has managed assets worth $122.2 million while sees light volume of nearly 37,000 shares. Expense ratio came in at 0.63%. The product is slightly concentrated on the top 10 firms at nearly 46.2% of total assets.

Here again, the ETF is tilted toward mid caps which make more than half of the portfolio while small and large caps take the remainder. The top three sectors include engineering and construction (27.1%), construction materials (13.2%) and homebuilding (10.2%).

What Lies Ahead?

The sluggish trend in the homebuilder ETFs might continue in the near term given that the funds have fallen slightly below its long-term 200-day moving average, indicating that these might fall further. Additionally, all of the five industries classified under homebuilding or construction have a poor Zacks Rank within the bottom 33%, as per the Zacks Industry Rank, suggesting that more pain might be in store for the homebuilders (read: Sell in May and Go Away with These Inverse ETFs).

However, the RSI of XHB and ITB is near 42 while that for PKB is near 37. This suggests that the funds are slowly approaching the oversold territory and has room for a strong run up in its prices in the coming months, especially when homebuilder fundamentals improve.

Further, all the ETFs have a favorable Zacks Rank of 3 or ‘Hold’ rating with High risk outlook, indicating that they have room for upside as we head into second half of the year but require patience for extreme volatility (read: 3 Low Risk ETFs for Market Turmoil).

A recovering U.S. economy and accelerating job market would boost demand for new homes. Mortgage rates are declining, making the loan cheaper and attracting home buying at the end of the spring season. Moreover, the latest comment from the Fed about keeping the interest rates at lower level for the considerable period of time would further provide support to the stocks and the ETFs.

Bottom Line

Given the current fundamentals, investors should consider staying on the sidelines until the sector bottoms out and then consider the slump as a huge buying opportunity.

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