How to ride the US housing recovery

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Although there are understandable concerns in the global economy – ranging from Europe’s financial woes to China’s economic slowdown – one bright spot is the steady improvement in America’s housing sector. The fundamentals in this once stricken industry are turning around, providing opportunities for investors that don’t mind dabbling in foreign markets.

Many local brokers now offer relatively easy access to international markets – especially Wall Street – and with the advent of exchange-traded funds (ETFs), it has never been easier to gain exposure to favoured sectors without having to worry about which individual companies to buy.

An investment option

The SPDR S&P homebuilders ETF, for example (code XHB), provides exposure to just under 40 home building companies within the US S&P total market index. Among its top ten holdings is Home Depot, one of America’s leading home improvement retail chains. Lowes, the hardware and home improvement retailer, is another large holding. There’s also a collection of actual home building companies, such as Lennar and Toll Brothers.

Along with the US market overall, this ETF bottomed in early March 2009 at a mere US$8 compared with a peak of US$46 at the height of America’s housing boom in early 2006. It has since enjoyed steady though not spectacular improvement, in line with the very sluggish improvement in the US housing sector.

Indeed, despite record low interest rates and the biggest downturn in US home building on record – with new home construction touching 50 year lows – the housing recovery has been held back by high unemployment, tight credit conditions, and excess stock of housing from the previous building boom.

Changing tide

Slowly, but surely, however, the sector’s outlook is improving. After years of low construction, the backlog of excess new homes has been reduced. Falling home prices have also boosted affordability. An influx of former homeowners into the rental market has pushed up rental yields, making construction of new apartments more attractive. The early pickup in housing starts over the past year has been mainly in multi-unit construction, but even construction of single-family homes now also appears to be picking up.

US housing starts are already up 23% over the past year, but remain around half their average level of the past half-century.

More recently, there have been signs of a levelling out and even tentative increases in house prices. With greater confidence that house prices have stopped falling, sale of new and existing houses are also rising.

Strong stock price recovery

These improvements have naturally been reflected in the home building sector of the share market. The SPDR S&P homebuilders ETF, XHB, has been outperforming the S&P 500 index since around October last year. While the S&P 500 has risen by around 25% since its lows of late last year, the homebuilding ETF has increase by 75% from US$12 to US$21.

As might also be expected, more analysts are jumping on the homebuilder bandwagon. Citing an improving outlook for the sector, Goldman Sachs analysts this past week upgraded their rating on homebuilders from ‘neutral’ to ‘attractive’.

Of course, America’s housing recovery is unlikely to become robust for a while yet. Indeed, the sector still faces strong headwinds from high unemployment, low consumer confidence, tight lending conditions given fragile bank balance sheets and ongoing European/China-related global concerns.

Interest rates are also at rock bottom levels and can’t really go much lower. Last but not least, America faces a possible sharp lift in taxes and cuts in spending by the Federal Government early next year unless Washington can reach a speedy compromise after the November Presidential election.

All that said, interest rates are likely to remain low and supportive for several more years. And there is one thing investors can be sure about – America will need to eventually build houses again and in much greater numbers than it is doing at present.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.

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