The year 2016 is just around the corner, and with it comes the chances of higher interest rates. Yet contrary to popular belief, that is the exact ideal time to own homebuilders and, more specifically, homebuilders ETFs.
When interest rates rise, common sense suggests it’s a negative time for all things sensitive to consumption. Naturally, that would include homebuilders. But the reverse is true. When the Fed raises its benchmark rates, short-term bond yields of three years and shorter do tend to rise.
But as short-term rates rise, the long-term inflation outlook falls. And as the long-term risk of inflation falls, Treasuries with maturities of 10 years and longer tend to fall, too. And since rates for mortgage loans are closely correlated with 10-year U.S. Treasuries yields, mortgage rates could also fall.
And if mortgages are cheaper, it’s easier to buy a home.
At the same time, existing homes inventories are close to lows established in 2012. Currently at 2,140,000, that figure is close to half what it was in 2007. That creates pressure for new housing, and that means higher demand for new homes.
So, as we turn to 2016, demand for new housing will crawl higher. Now combine that with the fact that home buyers will encounter cheaper interest rates in 2016 and … Voilà! What we have is a silver lining for homebuilders.
Without further ado, here are 3 ETFs to play the homebuilders sector.
Solid Homebuilder ETFs: SPDR S&P Homebuilders ETF (XHB)
Now, rather than allocating the fund’s entire $2 billion in assets on homebuilders stock, only 34% of holdings are allocated to homebuilders — including D.R. Horton Inc (DHI) — while the remainder is allocated to related industries.
The second largest allocation is building product manufacturers, which tend to have similar business cycles. Of course, their benefit is that they profit long before the home is finished. Obviously, that’s because you can’t build a new home without building materials.
Another sector that the XHB ETF diversifies with is home furnishing retailers. That segment, as you might expect, grows as new homes are built and purchased. And because home furnishing companies are not 100% correlated with homebuilders, that provides additional diversification.
The inclusion of the related sub-industries tends to give XHB ETF an edge.
Solid Homebuilder ETFs: iShares U.S. Home Construction (ITB)
Naturally, it shares some similarities with the XHB ETF. Its main difference is its aggressive allocation for homebuilders. As much as 65% of the fund’s total assets are allocated to homebuilders directly.
The fund’s main holdings include stocks like DR Horton and Lennar Corp (LEN). Making its allocation towards homebuilders more aggressive is the fund’s 40% cap on non-homebuilders stocks.
This fund’s advantage is that it is most closely correlated to new housing. Therefore, for those wishing to own mostly homebuilders themselves, it is a solid ETF.
The most evident disadvantage is, paradoxically, its large allocation to homebuilders. That could mean that any slowdown among homebuilders could hit your portfolio harder.
That is especially true since it has a bigger allocation than the more diverse XHB ETF.
Solid Homebuilder ETFs: PowerShares Dynamic Building & Construction Portfolio (PKB)
The PowerShares Dynamic Building & Construction Portfolio (PKB) is, as one might expect, a dynamic ETF.
Unlike the other two ETFs, the PKB ETF tracks the Intellidex Index, which has an emphasis on momentum. Rebalancing of the asset allocation is done on a quarterly basis. That reallocation will depend on price momentum, earnings momentum, management action and various other more dynamic criteria.
Thus, the PKB ETF’s advantage is in its rather proactive nature. It enables the investor to maximize the momentum of the homebuilders sector. Indeed, since September, when homebuilder stocks started to rally, the PKB ETF outperformed its peers.
However, since the PKB ETF is driven by momentum, when homebuilders are weak it tends to underperform its peers. Hence, it’s best to use the PKB ETF in combination with the other two as an enhancer of performance.
As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.