Homebuilder ETFs Face a Tough Road Ahead

The housing sector of the U.S. economy has been battered and bruised over the last several years, as new home prices have plummeted, sales activity dried up, and unemployment skyrocketed toward double digits. A brief reprieve came recently in the form of generous government subsidies for first time home-buyers, a program designed to spark an industry that had been driven to the brink of collapse by a prolonged economic downturn. But all good things must eventually come to an end.

With government support of the housing market drawing to a close, investors have been unsure of exactly what to expect from the housing market. They got a hint of things to come on Wednesday, and the outlook wasn't pretty. A report from the Commerce Department showed that new home sales plunged to a record low in May, dropping almost 33% from April levels. At a seasonally adjusted annual rate of 300,000, new homes sales were significantly below analyst estimates; economists had expected a decline of about 21% to 400,000 homes sold. The 300,000 homes sold represented the lowest mark since the government started keeping track of the data in 1963, and was driven by declines in all four regions of the country.

"The housing sector is a sore spot within the broader economy, which suffered painfully weak job growth and floundering retail sales in May," writes Jeff Bater. A major factor in the big decline was the expiration of a government program that had subsidized home purchases. First time buyers were eligible for an $8,000 tax credit and repeat buyers were eligible for a $6,500 credit, leading to a surge in activity prior to the April 30 expiration. Wednesday's report seemingly indicates that the uptick in sales in recent months was primarily attributable to the program, and that underlying fundamentals remain weak.

Beyond the Commerce Department report, there are several other reasons to be wary of homebuilders. According to an analysis of Census data by Brookings Institution demographer William Frey, urban areas are growing much more quickly than suburbs, a trend that could mean future demand for new homes will decline further. "Suburban growth lagged from July 2008 to July 2009, another indication of how the recession and housing bust have kept people trapped in place," writes Conor Dougherty. Not surprisingly, builder confidence has plummeted in the wake of the credit's expiration, as many in the industry see tough times ahead.

Homebuilder ETFs in focus
Homebuilder ETFs posted moderate gains on Wednesday, perhaps indicating that some investors feared the tax credit hangover would be much worse. But beyond that boost, the outlook for the industry remains challenging, particularly after the dismal projections coming out of the most recent Federal Reserve meeting. For investors looking to short the building industry, ETFs offer a cheap and efficient option. Below, we profile three ETFs offering exposure to homebuilders:

  • SPDR S&P Homebuilders ETF (NYSE: XHB  ) : This ETF tracks the S&P Homebuilders Select Industry Index, an equal-weighted benchmark comprised of about 25 companies operating in the homebuilding sub-industry. In addition to actual building firms, XHB's holdings include companies less directly involved in the space, such as Owens-Corning, Sherwin-Williams, and Williams-Sonoma.

  • iShares Dow Jones U.S. Home Construction Index Fund (NYSE: ITB  ) : This ETF tracks the performance of the Dow Jones U.S. Select Home Construction Index, a benchmark that consists of about 25 companies falling under the home construction sector of the U.S. equity market. Unlike XHB, many of ITB's biggest holdings are directly involved in construction activities; NVR, Pulte, D.R. Horton, and Toll Brothers are among the largest components.

  • PowerShares Dynamic Building & Construction Portfolio (NYSE: PKB  ) : This ETF tracks … PowerShares' … Dynamic Building & Construction Intellidex Index. Similar to the homebuilders SPDR, PKB's holdings consist of several companies tangentially related to the construction industry; Owens-Corning, Lowe's, and Home Depot are all among the largest individual weightings.

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Sherwin-Williams is a Motley Fool Stock Advisor recommendation. Lowe's and Home Depot are Motley Fool Inside Value recommendations. Try any of The Motley Fool's investing newsletters free for 30 days. The Motley Fool's disclosure policy is a stickler.


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