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).
At the beginning of the year, the case for the iShares U.S. Home Construction ETF (BATS:ITB) was almost purely contrarian. ITB shares dropped 31% in 2018, including a fourth-quarter plunge to a 22-month low. That’s no longer the case. ITB, my pick for the Best ETF of 2019, has indeed been one of the best ETFs out there, rallying 41% so far this year and touching a 20-month high.
The gains make some sense. Home sales have been choppy, but still reasonably strong. Lower Fed rates have led to lower mortgage rates – and presumably higher housing demand.
The economy continues to run nicely, with unemployment at historic lows. Meanwhile, ITB simply was too cheap, particularly when looking at its key holdings.
The question now is whether the easy money has been made, and it’s likely that it has. ITB has been notably consistent so far this year, gaining 16% in the first quarter, 8%-plus in Q2, and 11% in the third quarter. I’d expect smaller-but-still-positive gains in Q4.
Homebuilder stocks still look reasonably cheap, and interest rate moves should boost demand for new housing and spend on remodeling.
That said, there are some valuation concerns in the ETF. And macro worries still loom. ITB has been one of the best ETFs so far this year. I don’t know that I’d expect a repeat of that going forward – but it should still be a good ETF, particularly for macro bulls.
The Case for ITB
The case for ITB at the moment has two pillars. The first is that the ETF still isn’t all that expensive, looking both backward and forward. The ETF still trades below 2018 highs. In fact, since the beginning of last year, ITB is down 3%, while the S&P 500 is up 10%.
That gap should narrow in an upcycle, and ITB still potentially has double-digit upside from here if it does. That would move valuation to highs briefly touched in 2018.
Meanwhile, the two core holdings — homebuilders D.R. Horton (NYSE:DHI) and Lennar (NYSE:LEN) — still trade at reasonable levels despite huge YTD gains. DHI has risen 49% – but trades at 11x 2020 consensus EPS. Lennar is up 41% – and still has a forward multiple below 10x.
Those two stocks account for over 25% of the portfolio. At this point in the cycle, neither is necessarily going to get a big earnings multiple – but it’s not as if either stock is anywhere close to bubble territory.
The second pillar is that the drivers of the upside so far this year still look intact. Economic figures look good. Consumer confidence is high. There’s still a need for new housing supply, particularly at reasonable prices. And lower interest rates add a potential catalyst for new housing sales in the coming quarters.
It’s always tempting to take profits and sell the winners. But a bull would argue that, fundamentally, there’s little reason to do so just yet.
The Risks to One of 2019’s Best ETFs
All that said, ITB, as noted, has gained 40%-plus already. Both LEN and DHI – as well as other homebuilder stocks – traded at huge discounts to analyst targets last year. That’s no longer the case.
Remodeling plays Home Depot (NYSE:HD), Lowe’s (NYSE:LOW), and Sherwin-Williams (NYSE:SHW), meanwhile, account for over 13% of the portfolio at the moment. Valuations in those stocks, particularly HD stock, look potentially stretched.
And while the economy is good at the moment, there are fears that the cycle will turn. After all, this is the longest economic expansion in history.
It’s possible the 2020 U.S. presidential election will drive uncertainty and lead potential buyers to put off house-hunting. And as far as the ETF goes, it doesn’t take a cyclical swing just rising cyclical concerns, which we’ve seen on occasion this year to send it downward.
There are risks here. That said, I also argued after Q2 that gains might slow – and ITB has gained another 10%+. The potential rewards still seem to outweigh the risks. I’d expect the see the iShares U.S. Home Construction ETF create new highs – and catch up with the S&P 500. That suggests that one of the best ETFs of 2019 should, at least, continue its run for the rest of the year.
As of this writing, Vince Martin has no positions in any securities mentioned.