Tough Time For Homebuilding ETFs Despite Fed's Dovishness?

Sentiment among U.S. homebuilders recorded its first slump this year despite declining mortgage rates. Per the monthly National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index (HMI), builder confidence dropped to 64 in June from 66 in May and 68 a year ago. U.S. homebuilding also declined in May and building permits have been soft this year, while upbeat demand should have kept construction steady (read: U.S. Homebuilder Sentiment Data Soft in June: ETFs in Focus).

What’s Bothering the Space?

The housing market has been struggling for five quarters in a row. Shortage of land and labor is an age-old problem for the sector. The imposition of tariff on imported Canadian lumber in the Trump era is a new concern for the industry. Historically, lumber reached an all-time high in May of 2018. This year, its cost has gone up 18.9%. So, overall, cost structure for homebuilder is on the rise. Threats of “excessive regulation” is also hurting construction.

Raymond James analyst Buck Horne noted that valuation is pretty high in the homebuilding space. “Valuations are now trading above cyclical median multiples,” per the analyst, even as fiscal 2019 earnings estimates have skidded about 9% since the start of the year, as quoted on MarketWatch. Lennar Corporation (NYSE:LEN) shares are up 33.1% this year whileKB Home (NYSE:KBH) has gained about 31.4% despite a not-so-encouraging operating backdrop.

Investors should also note that higher operating costs make homes costlier, which is deterring entry-level buyers from entering the housing market. According to the latest data, house prices increased 3.7% in March from a year ago, outperforming wages, which increased 3.1% in May, per Reuters.

All these factors are weighing on the space despite a dovish Fed and low mortgage rates. Raymond James analyst Buck Horne further noted that data “in key homebuilding markets are indicating a late-season boost in buyer traffic and home sales, most likely due to the fall in mortgage rates. That said, quick drops in mortgage rates often have an effect of pulling forward contracts from home buyers, which can leave an air-pocket of demand in subsequent months.”

What Lies Ahead?

Further dive in mortgage rates amid rising wager on a rate cut this year and some upbeat earnings could boost the space in the near term though the medium term looks bleak amid overvaluation concerns. Investors should note that SPDR S&P Homebuilders (NYSE:XHB) ETF XHB persistently beat the S&P 500 in the past six-month time frame on cues of dovish Fed activity. It means the move of policy easing is already priced-in. So, much of a bump from here is less expected.

Along with XHB, investors should keep track of iShares U.S. Home Construction ETF (WA:ITB) , Direxion Daily Homebuilders & Supplies Bull 3X Shares NAIL and Invesco Dynamic Building & Construction ETF (PKB) in a volatile operating backdrop for the homebuilding market (see all industrial ETFs here).

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