Two Housing ETFs That Are Doubling the S&P 500’s Returns

A week ago in this space I wrote about the improving forecast for the housing market and why now is a good time to invest in housing stocks. But there's a much easier way to play the housing recovery than to go searching for individual stocks – by investing in exchange-traded funds (ETFs) that track the housing industry itself.

Two ETFs in particular stand out. As the U.S. economy continues its post-recession recovery, the housing market forecast is finally starting to improve. New home starts increased to an average of 640,000 units over the last six months – the highest six-month average since early 2009. The National Association of Homebuilders reported last month that confidence is at its highest level since May 2007.

Homebuilding is on the rebound. So one way for investors to play the housing recovery is to buy shares of two ETFs that track home construction and home improvement stocks.

As the housing market forecast has improved in recent months, these ETFs have risen sharply. Even while the S&P 500 is off to one of its fastest starts ever to a year – vaulting 12.5% over the first three months of 2012 – the following ETFs have managed to double that near-historic pace.  
iShares Dow Jones U.S. Home Construction (NYSE: ITB)

The ITB tracks some of the biggest homebuilders and home improvement companies in the U.S.  Luxury homebuilder Toll Brothers (NYSE: TOLL), single-family home giant D.R. Horton (NYSE: DHI), Home Depot (NYSE: HD), Lowe's (NYSE: LOW) and Sherwin-Williams (NYSE: SHW) are among its primary holdings.

So it's telling that the ETF is up 24% in 2012 and 75% since October 3. At $14.75 per share, ITB is trading close to its 52-week high of $15.48. But the housing market is just now beginning to show signs of life. Permitting increased 5.1% last month to reach its highest rate since October 2008. Plenty of new homes are waiting to be built – and the companies that build them should prosper.

SPDR S&P Homebuilders (NYSE: XHB)

Lowe's and Home Depot are also among this ETF's 37 holdings. So too are building supplier Masco Corporation (NYSE: MAS), home décor designer Pier 1 Imports (NYSE: PIR), and bedding companies such as Tempur-pedic International (NYSE: TPX) and Select Comfort Corporation (Nasdaq: SCSS). And XHB has performed even better than ITB in recent months, gaining 25.6% in 2012 and 72% since early October.

Not only has XHB almost exactly doubled the S&P's performance in the first three months of this year, it has outpaced the index for the past year. It shows that the market fully expects a turnaround in homebuilding, which is why – despite the ETF's hefty returns of late – XHB still has plenty of upside as the housing market recovers.

Housing is the cheapest it's been in nearly a decade right now. Just this morning it was reported that home prices dropped for a fifth consecutive month in January, reaching their lowest point since late 2002.

Since peaking in July 2006, housing prices have fallen by an average of 34% – a decline that's on par with the housing crash that occurred during the Great Depression. When you adjust for inflation – and add in the fact that the average interest rate on a 30-year mortgage is 4.11% – home prices today are as cheap as they were in 2000.

But it appears that the housing market may have finally bottomed. With the U.S. economy improving and the unemployment rate declining, people are starting to buy houses again. Housing starts are up over the last six months. And with the Federal Reserve intent on keeping interest rates near zero through at least 2014, that means mortgage rates should also remain low.

That will encourage more people to buy houses and more homebuilders to build new homes. Homebuilding and home improvement stocks should benefit as the housing market recovers – as should the ETFs that track them.  And while these ETFs have been gangbusters for the past few months, they have plenty of room to run before challenging their all-time highs.

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