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Are Housing ETFs in Trouble?

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Homebuilders were no doubt the biggest beneficiary of the Fed's bond-buying policy and one of the strongest performers last year. But more recently, fears over rising rates have kept the space under pressure.

Inside the Slump

Homebuilders suffered a huge sell-off in May, plunging close to double digits in that time frame and severely underperformed the overall market. This decline continued for much of June, especially after the FOMC meeting (read: Are Housing ETFs Back on Track?).

At the FOMC meeting, Bernanke indicated a slow down bond purchase later this year, and discontinuation if unemployment hits 6.5% at some point in 2014. The potential exit of this massive QE program has led to the slump in most of the homebuilders’ stocks.

Rising mortgage rates could severely impact the current housing recovery and raise concerns on the demand for new homes and the homebuilders’ profit margin.

Will Solid Data Help?

However, an improving labor market, rising consumer confidence and tight inventory are infusing bullishness into the sector. The sector looks promising according to the recent solid housing data (read: Homebuilder ETFs Rise on Even More Strong Data).

First, the NAHB housing market index jumped from 44 in May to 52 in June, representing the highest reading in seven years. Second, existing home sales data hit the highest level since Nov 2009 with a seasonally adjusted annual rate of 5.14 million. The figure is up 2% from the prior month and 12.9% from the year-ago month.

Finally, housing starts increased 6.8% to a seasonally adjusted annual rate of 914,000 while building permits fell 3.1% in the month.

Homebuilder ETF in Focus

Despite the worries about rate increases, investors can view the recent dip in the homebuilding space as a buying opportunity. Below, we briefly highlight two of the top funds in the space which could be great picks for investors who believe that the housing market will storm higher after its recent dip:

iShares Dow Jones US Home Construction ETF (ITB - Free Report)

This popular homebuilder ETF follows the Dow Jones US Select Home Builders Index, giving exposure to about 29 companies in the space. The fund is extremely liquid trading in volume of more than 4.6 million shares a day and charges investors 45 basis points a year in fees (read: Top Zacks Ranked Construction ETF- ITB).

The product provides exposure to pure homebuilders making up for about two-thirds of the assets, leaving a bit for retail firms and building material companies. In terms of individual stocks, mid caps dominate the fund with more than half of the assets.

The fund is highly concentrated in its top 10 holdings with the highest allocation going towards Pulte Group (PHM), Dr Horton (DHI) and Lennar (LEN).

ITB struggled in June, losing about 7.7% in the month. However, ITB has added about 5% to start July and may now be back on track. The ETF currently has a Zacks ETF Rank of #1 or Strong Buy rating with a Medium risk outlook.

SPDR S&P Homebuilders ETF (XHB - Free Report)

This ETF follows the S&P Homebuilders Select Industry Index, giving investors exposure to about 37 companies in the space. Volume on this ETF is really good, coming in just under six million shares a day while AUM is also solid at over $2.5 billion. The fund charges 35 basis points a year.

The fund uses an equal weight strategy, so no single security makes up over 3.33% of assets, ensuring a good level of diversification. This approach gives the fund a tilt towards small and mid cap securities, as just 10% of the ETF is in large cap stocks.

Meanwhile, investors should also note that the ETF goes beyond just homebuilders, holding companies that are in the retail segment or household appliances’ corner of the housing market.

Despite the equal weight strategy, XHB lost over 4% in the month of June. But so far in July, the ETF has seen a solid performance, adding about 5% in the time frame. Currently, the ETF has a Zacks ETF Rank of #3 or Hold rating with a Medium risk outlook (read: The Best ETFs for the Housing Recovery?).

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