Editor’s note: This article is a part of InvestorPlace.com’s Best ETFs for 2019 contest. Vince Martin’s pick for the contest is the iShares U.S. Home Construction ETF (BATS:ITB).
Heading into 2019, the case for the iShares U.S. Home Construction ETF (BATS:ITB) was reasonably simple. Pretty much anything housing-related had been sold off big in 2018. In fact, ITB stock fell some 31% for the year. Yet the economy still seemed strong. Broad markets, even with a rough Q4, were in decent shape. Economically sensitive housing-related stocks were plunging despite the news simply being not that bad.
That divergence was why I named ITB as my pick for the Best ETFs of 2019 contest. So far, it has been a solid choice, with the ITB ETF gaining 29% year-to-date against a 17% rise in the S&P 500. Homebuilder stocks have risen, as have most of the industry’s retailers and many of its suppliers.
But at this point, the case for ITB gets a little thinner. After the first quarter, the fund had returned 16%, but that was only modestly better than low double-digit gains in most broad market indices. And so I made the case in late March that ITB still had some catching up to do.
Three months later, ITB hasn’t completely caught up. Since the beginning of 2018, the fund remains negative against an ~10% gain for the S&P 500. But the gap certainly has closed. As such, this ETF will need some outside help if it’s going to keep rising.
The Case Against ITB as One of the Best ETFs
Up 29% YTD, it certainly seems like the easy money has been made here. That seems particularly true looking at the fund’s key holdings: 27% of assets are in the country’s two largest homebuilders, D.R. Horton (NYSE:DHI) and Lennar (NYSE:LEN).
Both stocks have rallied sharply this year (+29% for DHI, +33% for LEN), driving a good chunk of the fund’s gains. Another 40% of the fund owns smaller homebuilders — most of which have followed similar patterns. Most of the group is below their highs, but many have at least returned to 2018 trading levels.
Home Depot (NYSE:HD) has gained nicely, and is threatening a new all-time high. Lowe’s (NYSE:LOW) has underperformed, but is still positive. In December, ITB was a case of buying a group of stocks at or near the lows. That’s not the argument anymore.
Now, ITB needs at least a few components to break out from the highs — and not just rebound off the lows. That might be tough. Tariffs are pressuring margins in the space. Trade war concerns are affecting the macroeconomic outlook. There’s still a belief that a downturn in the U.S. has to be on the way at some point, as we head into year eleven of the economic expansion. Homebuilder stocks, in particular, likely would take a big hit.
At this point, risks are rising and valuations aren’t as cheap. That’s a combination that suggests, at the least, that ITB’s appreciation is going to slow in the second half.
The Case for the iShares U.S. Home Construction ETF
For market and macro bulls, however, ITB still looks like a solid pick. The ETF remains about 15% below early 2018 highs. With some help from lower interest rates, which would lower mortgage costs, and economic strength, it could re-take those highs, suggesting another 20% or so in upside.
From a longer-term standpoint, the ETF still sits below where it traded back in 2006. ITB started trading on May 1st of that year. The housing crisis followed, and in less than three years, 85% of its value had been wiped out. It has been a long climb back from those lows, but if the economy cooperates, that climb can continue.
That’s the key point, though: if the economy cooperates. To even consider ITB at this point, an investor truly has to trust both the economy and the broad market. If trade war concerns ease and/or if strong U.S. job and macro growth continues, ITB will keep rising. And, in that scenario, the ETF likely will outperform broad markets in the second half, just as it did in the first.
But this is a different argument than it was six months ago. Then, the ETF looked like it was pricing in an almost-certain recession. That’s just not the case anymore. For macro bulls, the ITB ETF is a way to get leveraged upside on more good economic news ahead. But it’s not as cheap, or attractive, as it was six months ago.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
