This Sector Could Return 20% for Those Who Look Past the Headlines
When I read Wednesday's headlines on housing starts, I grinned. Not because I was happy with, "Housing starts fall 9.9% in June," as was reported in USA Today, but because I know that most of the time, the headline numbers in housing fail to tell the whole story.
You see, when it comes to just about every economic report, including housing starts, you have to dig into the details to find the actual tradable data points.
So, why did housing starts fall by 9.9% in June?
Well, that headline drop was due mostly to a decline in the "multi-family" segment. According to the Commerce Department, multi-family starts fell by 26.2% in June from May. That's certainly not an encouraging metric, but what housing market watchers such as me are really concerned with is the much more important single-family starts number. On that front, single-family starts remained near April and May levels, with a decline of just 0.8% in June from the prior month.
Why is the single-family component to housing more important than the multi-family housing segment? The answer is simple, and it is because single-family starts account for about 70% of all construction activity.
"Single-family housing starts give a much-better picture of the health of the residential real estate market," said Tom Essaye of The 7:00's Report. He added, "The June data was basically unchanged, so this report doesn't imply that higher mortgage rates led to a significant drop in the residential real estate market, despite the headline."
You see, because of the Fed's "taper talk" in June, there was a decided spike in yields on the 10-year Treasury note. Those yields are closely tied to mortgage interest rates, and that caused the cost of borrowing for a home loan to spike to its highest level in two years.
The jump in mortgage rates also spurred fear-mongering headlines such as, "Did Bernanke kill the housing recovery?" Well, judging by the June housing starts data, the most important part of the housing market was little affected -- and that means opportunity for the savvy trader.
Before I get into that opportunity, it's important to point out another aspect of the Commerce Department's June data, and that is building permits. To me, this metric is even more important than the single-family housing starts number, because it is a leading indicator. The building permits number is out in front of housing starts by anywhere from three to six months, so it's a harbinger of things to come for housing.
Once again, the headline number showed that there was a big decline, with building permits falling 7.5% from a seasonally adjusted rate of 985,000 in May to 911,000 in June. However, if you dissect the data here, you once again find that the decline was fueled by a drop in multi-family units, and not the more important single-family measure. When it comes to single-family building permits, they actually rose 0.6% to 624,000 units from a revised 620,000 units in May.
Yes, I'll grant you that the headline figures in housing don't look too good, but the details show that there's no real drop off in the most important metrics, and that's something that I suspect will drive homebuilder stocks higher going forward.
My favorite way to play this is the SPDR S&P Homebuilders (NYSE: XHB), an exchange-traded fund (ETF) that holds the biggest and best housing-related stocks available. With XHB, you get exposure to homebuilders such as Toll Brothers (NYSE: TOL), but you also get retailers like Home Depot (NYSE: HD) and Williams-Sonoma (NYSE: WSM), as well as heating and air conditioning companies such as Lennox International (NYSE: LII).
The diversification in this index makes it a go-to play for housing bulls -- and for those who see beyond the housing start headlines.
Recommended Trade Setup:
-- Buy XHB at the market price
-- Set stop-loss at $28.15, approximately 8% below the current price
-- Set initial price target at $36.75 for a potential 20% gain by year-end