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A Sustained Rebound Ahead for Homebuilders?

This ETF offers the greatest exposure to homebuilding companies, which have significantly trailed the broader market since the start of 2013 but which recently have posted some good news.

Robert Goldsborough, 08/29/2014

Recently released housing market data have shown some meaningful improvements, with both the new- and existing-home markets gaining strength simultaneously. Reports have shown nice increases in builder sentiment, housing starts, and existing-home sales, with data also coming in above expectations and housing start data from the previous month being revised upward.

This story has been very different from the way the housing market has looked over the past year. Previously, the housing market has shown a marked divide in its behavior: periods where new-home sales (or starts) did better and periods where existing-home sales did better. It's been rare for both to exhibit the same behavior. Most recently, that trend has broken, with strong performance both from new-home activity and existing-home sales. In addition, homebuilder confidence grew in August for the third straight month.

What has been driving this rosy housing news? Morningstar's analysts see a confluence of factors, including lower mortgage rates, moderating home-price increases, and generally easier lending conditions.

Looking ahead, we are taking a positive view toward the housing market, with an expectation of continued moderate growth in the sector.

Investors who believe that more good news is ahead for homebuilders might consider a sector-specific ETF devoted to the homebuilding industry. iShares US Home Construction ITB has the greatest exposure to the housing sector. Because ITB is a concentrated bet on a very narrow segment of the market, we view this fund as a tactical investment, suitable only as a complementary satellite holding in a diversified portfolio. Investors should take note that the housing sector is highly cyclical and sensitive to employment and credit conditions.

Aside from homebuilders (which account for about 64% of the fund's total assets), this fund also holds building-materials and fixtures producers (20%), home-improvement retailers (12%), and furniture companies (4%). This fund contains 36 companies and is top-heavy: The top-10 holdings account for almost 62% of total assets.

Homebuilding companies are not high-quality firms. This industry has low barriers to entry, and many firms hold significant land banks on their balance sheets, which can tie up large amounts of capital for long periods of time. The cyclical nature of this sector makes it an unattractive long-term holding.

Unsurprisingly, ITB is a volatile fund. During the past five years, it has had an average standard deviation of returns of 25.7% compared with 13.1% for the S&P 500.

Robert Goldsborough is an ETF Analyst at Morningstar.
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