Sectors To Watch: Homebuilders Are Ready To Run

| December 10, 2012 | 0 Comments

The US housing market is heating up. 

It’s a welcome sign for the US economy that’s struggled to grow without a contribution from the housing sector.  But it’s even better news for homeowners and banks who have bared the brunt of the worst real estate bust since the Great Depression.

Not surprisingly, the revival was sparked by investors. 

They’ve been buying distressed properties at rock bottom prices out of foreclosure over the past few years.  The depressed prices made it easy to turn a quick profit or generate solid returns by renting the properties.

In fact, the return on investment was so good that investors have burned through virtually the entire inventory of distressed properties.  The supply of existing homes for sale has fallen 22% from a year ago to 2.14 million units.  That represents a 5.4 month supply of homes at the current sales pace.

The lack of distressed properties for sale has removed the biggest drag on home prices.  As a result, existing home prices surged 10.9% in the last year.

As existing home prices go up, it’s making it harder for investors to make money.  But as investor demand wanes, household demand is accelerating.  Today, prospective homeowners are taking advantage of record low mortgage interest rates to dramatically reduce the cost of homeownership.

Put simply, this is the early stage of a reinforcing cycle.

In other words, as housing prices recover, homeowners feel wealthier.  So they’re more likely to sell and move up to a more expensive house.  This creates more demand and higher prices and on and on down the line it goes. 

Don’t forget, many homeowners who would have already moved up to a more expensive house delayed their purchase.  But now that home prices are on the upswing, homeowners are unleashing years of pent up demand. 

What’s more, the price gap between new and existing home prices is shrinking.  As existing home prices rebound, new homes are becoming cheaper relative to the cost of an existing home. 

Yet, inventory levels of new homes remain near historical lows.  If homebuilders are going to keep up with demand, they’ll need to dramatically boost production next year.

Investor optimism for an increase in construction activity has fueled a strong performance in homebuilder stocks this year.  In fact, they’re some of the best performing stocks this year.

So far this year, the SPDR S&P Homebuilders ETF (XHB) is up a whopping 50%.   You just don’t see ETFs that cover an entire industry soar 50% in less than a year very often.

Amazingly, the homebuilder ETF has outperformed the S&P 500 by 35% this year!

However, XHB ran into a road block a few months ago. 

The impending fiscal cliff of tax hikes and spending cuts took the wind out of XHB’s sails after reaching a new 52-week high in early November.  Since then, it has settled into a trading range between $24.50 and $26.50.

Investors are worried that going over the fiscal cliff would throw the US economy into recession or that politicians could limit the mortgage interest tax credit in order to increase tax revenue.  Both of which could throw cold water on the housing recovery.

In my opinion, these fears are overblown.  As soon as politicians deal with the fiscal cliff, XHB should be off the races. 

If it does, buying call options on XHB could generate some quick profits.      

Good Investing,

Corey Williams

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Category: Sectors To Watch

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.