Building Something With Homebuilders ETFs

With the Federal Reserve inching closer to raising interest rates, investors are increasingly scrutinizing sectors and industries for positive correlations and vulnerabilities to higher borrowing costs.

On the surface, consumer discretionary stocks and the corresponding exchange-traded funds would not appear to be the best rising rates plays.

Despite presumed ebullience surrounding regional banks in a rising rate environment, homebuilders equities and ETFs such as the SPDR S&P Homebuilders (ETF) XHB are also seen as potential laggards after the Fed boosts rate. However, there is an alternative view here worth considering, and it holds that XHB might just have more upside ahead of it.

Related Link: A Global Real Estate ETF With Currency Protection

The Argument For XHB And Peers

Gains for homebuilders and stocks would be even more impressive if not for a slump that started in August and lasted well into September. However, the aforementioned data points have sparked a rebound in the homebuilder space, and that is proving to be good news for a new leveraged ETF, the Direxion Daily Homebuilders & Supplies Bull 3X Shares NAIL.

As it is, the equal-weight XHB has climbed nearly 7 percent year-to-date, which suggests the ETF has enjoyed the consumer discretionary group's showing as the best-performing sector through the first 11 months of 2015.

“Digging deeper, we believe homebuilders and the more discretionary housing related industries are attractive due to an improving employment picture, as well as rising home sales and prices,” said State Street Global Advisors Vice President David Mazza in a recent research piece.

XHB differs from rival homebuilders ETFs due to its robust exposure to the discretionary/retail side of the residential real estate industry. Sure, homebuilders account for over a third of the ETF's weight, but XHB also allocates a combined 35 percent to sub-industry groups that are considered retail or discretionary. That includes an almost 8 percent weight to home improvement retailers, a group that is expected to deliver some of the most impressive earnings growth in the broader consumer discretionary sector.

“This is important as existing home sales make up approximately 90 percent of all home sales in the US, according to the National Association of Realtors. Therefore, XHB may be able to capture trends in the burgeoning housing market beyond new home construction, such as homeowners investing in and renovating their newly purchased or current homes,” added Mazza.

Consumer discretionary sector, the fourth-largest sector weight in the S&P 500, currently trades at a roughly 20 percent valuation premium to the benchmark U.S. equity index.