by John Jagerson and Wade Hansen | June 5, 2012 12:21 pm
If you became acquainted with the SPDR S&P Homebuilders ETF (NYSE:XHB) anytime during the first couple years after its market introduction, it probably left a bitter taste in your mouth. Few could argue that it earned a reputation (quite deserved) as a laggard that apparently knew only one direction in terms of performance. Its timing onto the scene could not have been less opportune, coming as it did just months before U.S. home prices peaked at the all time high and started a precipitous drop.
Ever since that time, homebuilders have had something of an inferiority complex to overcome in the minds of many investors. And it is understandable that preliminary signs of a housing recovery during the last few years have been met with skepticism, as all have turned out to be head fakes.
Bears have been making the case that a) real estate crashes take longer to recover from, and we are not done with ours yet, and b) Fed/government policy has served to keep the market from digesting the housing surplus and letting it find levels of natural demand from which a true recovery can build. So far they have been proven right, or at least more correct than the real estate bulls.
Click to Enlarge But lately, the homebuilders have been mounting a surprising rally. Even more unexpected is how resilient they have been in the face of the recent decline in the S&P 500. From its highs in early April, the S&P 500 has shed 8.7% while XHB is basically flat during the same time. And in the S&P 500’s attempt to muster a rebound last week, it managed a gain of only 1.9%, while XHB increased 6.6%.
Rather than ditching homebuilding stocks at the first sign of broad market trouble, investors have been treating it as a more defensive hedge. XHB has finally been feeling some love, and perhaps this is because of the nature of investor anxiety, which at present is focused firmly on Europe.
While few U.S. equity sectors would be protected in the case of widespread European contagion (since correlations tend to ratchet up significantly when sparks of systemic risk catch fire), homebuilders might offer better relative performance since they are not exporting their products to Europe and have little connection to Spanish banks or Greek austerity measures. They are firmly tied to the fates of the U.S. labor market, interest rates and consumer confidence, for better or worse. And right now this is decidedly for the better.
The U.S. certainly has its share of macro issues, and there is no reason to think that the bear arguments can be shaken for good quite yet. But stats coming in on the housing front have been topping expectations. Housing starts were up 2.6% in April, handily above expectations, and the National Association of Realtors announced that home sales rose 3.4% from March to April to a seasonally adjusted rate of 4.62 million.
Housing activity usually precedes home price increases by several months, so the fact we are seeing broad-based, albeit tepid, increases in prices indicates that homebuyers already have started to become more active and that small measures of confidence might be finding their way back into the real estate market.
While XHB still is down 54.4% from its high set in March 2006, it is up 155% from its lows of March 2009. It is important to note that since 2009, existing-home sales have recovered significantly better than new-home sales — a fact that at first blush would appear to detract from XHB’s prospects. However, the ETF is comprised of about 30% pure homebuilder stocks. The remainder is homebuilding-related companies such as Home Depot (NYSE:HD) and Pier 1 Imports (NYSE:PIR), which benefit equally well from a recovery in existing home sales, making XHB less dependent on only a new-home sales rebound.
Click to Enlarge The four-year chart here shows that XHB is no foreigner to volatility. Homebuilders are susceptible to economic issues impacting interest rates especially, as evidenced in their decline last summer when Standard & Poor’s downgraded U.S. debt. However, their rally during the past nine months has taken the ETF past a key resistance level at $20, and this price has served as robust support throughout this year while also marking the lower range of a four-month consolidation pattern.
Whether the homebuilders could weather a European crash remains to be seen. But right now, XHB is acting well and likely is the recipient of investor money that is cycling out of equities with greater European exposure. If Europe manages to keep the fiscal bombshells of its members within the collective EU net and the relative health of the U.S. economy is allowed to reflect in stock market performance, XHB should be a primary beneficiary.
Recommendation: Buy near support at $20-$21; breakout of consolidation could take the stock to $25-$27.
If you’re interested in trading options on XHB to take advantage of the continued climb higher, you need to make sure you give yourself plenty of time before expiration. Don’t get caught with a looming expiration date at the same time you are waiting for a breakout above the neckline.
If you want to decrease the amount of money you have to pay up front for the time value you are buying, you might want to consider entering a bull-call spread with an at-the-money or slightly out-of-the-money strike price for the long leg, and an out-of-the-money strike price just below or at the target price for the short leg.
John Jagerson and Wade Hansen are advisers for SlingShot Trader.
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