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Housing market was a drag on the economic recovery for quite some time but it is finally showing clear signs of bottoming out.

If we take a look at some of the housing data released in the past few days, the positive tone is quite evident. (Read: Obama or Romney? Win With These ETFs)

Home prices (per S&P/Case-Shiller 20-city index) have increased 5.9% through July this year, reflecting their strongest performance since 2005.

Home builders’ confidence index this month rose to its highest level since June 2006. It was the index’s fifth consecutive gain, though the index still remains much below its historical highs. 

Further, new home sales are now near their two-year high. Rising home sales are resulting from an improvement in demand-supply situation now. (See: Three Biggest Mistakes of ETF Investing)

Mortgage rates are now at their record lows and are expected to remain at low levels in the near future. Under the QE3 program, the Fed has pledged to buy $40 billion of mortgage-backed securities per month on an open-ended basis till the job market situation improves.  This aggressive move further supports the nascent housing market recovery. (Read: Are QE3 and Mortgage REIT ETFs a Winning Combo?)

That said, strong and sustained recovery in the housing market still appears to be far away, particularly in view of the labor market conditions.  Unemployment remains above 8% and the businesses are still hesitant to hire due to macroeconomic and fiscal cliff related uncertainties.

Further, millions of homeowners are still underwater on their mortgages and there is still a glut of foreclosed properties on the market, which will keep the lid on the prices. Also even though the interest rates are at ultra-low levels, the credit situation is still tight and thus many prospective buyers are forced to remain away from the market.

Based on the optimism that the worst may be over for the housing market, many homebuilder stocks have jumped more than 100% in the last 12 months. The housing related ETFs have also enjoyed a smooth run in the past few months.  (See: Protect Against QE with these Precious Metal ETFs)

Despite recent price rise, these ETFs may continue to outperform the broader market, if the housing market continues its uptrend. Per Zacks earnings analysis, Construction sector will be the best performer with a very strong 42.3% growth in the third quarter, whereas total market earnings will decline 3.4% from the third quarter of last year.

Below we take a look at the three construction ETFs and analyze which one is the most suitable for the investors seeking to benefit from housing upswing.

iShares Dow Jones US Home Construction Index Fund (ITB - ETF report)

ITB tracks the Dow Jones U.S. Select Home Construction Index, which measures the performance of the home construction sector of the U.S. equity market.

Top three holdings are DR Horton (9.56%), Lennar (9.56%) and Pulte Group (8.99%). The fund is heavily exposed to the Home Construction sector (64.3%), followed by Building Materials & Fixtures (17.6%) and Home Improvement Retailers (13.3%).

SPDR S&P Homebuilders ETF (XHB - ETF report)

The fund employs a replication strategy in seeking to track the performance of the S&P Homebuilders Select Industry Index, which is an equal weighted index of the homebuilding segment of a U.S. total market composite index.

Top three sectors are Building Products (28.4%), Homebuilding (27.0%) and Home-furnishing (15.41%). Top three holdings are Lennox Intl (3.67%), Lowes (3.61%) and Smith AO (3.59%).

PowerShares Dynamic Building & Construction Portfolio Fund (PKB - ETF report)

PKB seeks to match the performance of Dynamic Building & Construction IntellidexSM Index, which is composed of U.S. building and construction companies. Top sector allocations are Industrials (51.0%), Consumer Discretionary (35.8%) and Materials (13.3%). 

 

ITB

XHB

PKB

Date of Inception

5/1/2006

1/31/2006

10/26/2005

AUM ($ M)

1,375

1,942

39

Expense Ratio

0.47%

0.35%

0.63%

Number of Holdings

28

37

30

YTD Return

62.3%

44.4%

31.5%

Yield

0.37%

0.90%

0.09%

Average Volume (1 m)

2.8 million

6.4 million

46 thousand

Zacks ETF Rank

1

3

3

Looking at the costs, XHB has the lowest expense ratio and it also trades in higher volumes, resulting in tighter bid-ask spreads. ITB trades with an average (1 month) volume of 2.8 million shares compared with 6.4 million shares for XHB, while PKB is rather illiquid compared with the other two—trading just about 46 thousand shares.  XHB also has the highest yield among the three.

However, with more than 64% exposure to the home construction sector, ITB is most suitable of three ETFs to track the homebuilding market. Since XHB tracks an equal weighted index, it provides more diversity with top 10 holdings accounting for about 35% of total assets while ITB is much more top-heavy with more than 64% of the assets in top 10 holdings.

Homebuilders are expected to benefit the most from the early stages of housing recovery whereas the other related sectors will benefit more if the recovery gains momentum and the consumers have significant disposable incomes. Therefore, ITB appears to be the most suitable ETF for investors seeking to profit from housing upswing. Further, it is our top ranked (1-Strong Buy) ETF in the construction sector.

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