The strong start for the U.S. equity markets in 2013 finally seems to be losing some steam as the benchmarks have been showing signs of consolidation. In fact of late, the major economic indicators have also posted mixed results coupled with a decent earnings picture.
While unemployment levels have been declining marginally and the U.S. trade deficit has reduced, the negative GDP growth and the decline in industrial production has surely dented investor confidence somewhat. Apart from this, there was the Building Permits and Housing Starts data that was reported yesterday which posted a disappointing picture (read ETF of the Week: Industrial SPDR (XLI)).
The Housing starts data came in below the expectations of the market. This was enough to trigger a massive sell-off in the homebuilder ETF space. The iShares U.S. Home Construction ETF (ITB - ETF report) slumped 5.74%, whereas the SPDR S&P Homebuilders ETF (XHB - ETF report) lost 4.45% in yesterdays trading session.
The housing data is keenly watched by major market players as this data is widely regarded as one of the most important economic indicators. This is because the housing sector is strongly correlated with the economic sentiments in the broader market.
ITB and XHB track the equity market performance of companies from the housing sector. ITB tracks the Dow Jones U.S. Select Home Construction Index. Its portfolio comprises of 29 stocks with around 63% of its assets in the top 10 holdings (read Can Solar ETFs Continue Their Bull Run?). XHB tracks the S&P Homebuilders Select Industry Index and its portfolio comprises of 36 stocks.
Furthermore, it is prudent to note that ITB is considered to be a pure play in the housing sector, especially compared to XHB. This is because around 64% of ITB’s assets are allocated to the Home Construction industry; this is followed by Building Materials and Fixtures industry to which it allocates 18%.
Therefore around 82% of its total assets are allocated towards a pure play in the housing sector. On the other hand XHB is relatively less concentrated in the homebuilding space
Just to highlight the importance of the housing data on the homebuilder ETFs it should be noted that both ITB and XHB rallied massively following the extremely positive looking Building Permits and Housing Starts data last month. The ETFs registered single day gain of around 2.71% and 1.85% respectively (see Housing ETFs Rally on Solid Data).
Furthermore, this positive momentum was also carried forward in the subsequent trading sessions as well. And the positive looking housing starts data last month surely ignited the upward trajectory of the homebuilder ETFs.
However, things changed for the worse yesterday as the sell-offs have threatened to potentially upset the dream run of the homebuilder ETFs. Having said this it is important to appreciate that these ETFs have surged massively after bottoming out, causing valuations to surge as well.
In this regard, it can be said that the ETFs have been overheated for quite some time now. And one would imagine, a healthy correction was surely imminent. The weak housing starts data was just the catalyst that has triggered that correction.
Also, in terms of their trailing performance, ITB had returned almost 79% whereas XHB has surged 58% for the year 2012. Of course, fuelling the momentum of these ETFs thus far was a recovering housing market in the U.S. economy as well as a decent level of stability in the global economic picture.
Apart from this, the two ETFs have been going pretty strong this year as well with both up about 4% so far in 2013. And these figures are inclusive of yesterday’s massive sell off.
Given all this, it is prudent to imagine that the building permit and housing starts data impact the course of direction of the homebuilder ETFs in a massive way. However, the correction should not be viewed in an entirely negative manner. On the contrary it has provided a decent margin of safety for investors seeking entry in this space implying a ‘buy the dip’ opportunity.
This is particularly because the sell off has not only helped to neutralize the highly overbought ETFs, but also made valuations attractive again. In fact especially considering the longer term picture, things are still looking good for the homebuilder ETFs. ITB has a Zacks Rank of 1 or ‘Strong Buy’ and XHB has a Zacks Rank of 2 or ‘Buy’. Both these ETFs have a ‘Medium’ risk outlook. (see Top Ranked Homebuilder ETF in Focus: XHB).
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