XHB - XHB: Sell Rating Issued As Homebuilding Risks Rise

2023-09-08 12:00:23 ET

Summary

• XHB, an ETF that invests in stocks that build and maintain homes, has run its course.
• Unfortunately for XHB, a homebuilding ETF, it is rolling over and reaching a point of high risk, outweighing the reward, due to a combination of economic and price trend issues.
• Rapidly-weakening financial position of homebuyers and a frozen housing market contribute to the Sell rating on XHB.

I'm issuing a Sell rating on SPDR S&P Homebuilders ETF ( XHB ), one of the 100 ETFs I track closely for the list I will soon publish (free) on Seeking Alpha, which I call the Stock Market MRI. More on that another time.

The homebuilding stocks, and by association ETFs like XHB and popular peer iShares Dow Jones U.S. Home Construction Index Fund ETF ( ITB ), have been ripping higher since the October market lows last year. And, while they appear to be rolling over at the moment, as opposed to crashing, they have reached the point where my antenna is up. It says, "very high risk of major loss, compared to reward potential." In the investment system I developed and have evolved for 30 years, that equates to a Sell rating.

A combination of negative macro influences and a tenuous technical picture are likely to overwhelm XHB's portfolio, which includes a combination of homebuilding firms and companies that provide products and services that we use in our homes. At only 1.4x sales and 13x earnings, the current 36-stock portfolio for this $1.3 billion, 17-year-old ETF seems like it would be a fundamental-based consideration. But what is not in those numbers is the rapidly declining health of the US consumer and the real possibility that the market pushed this ETF's price too high, too fast.

This year, there has been a lot of building activity, driven by a shortage of homes. However, there is also a shortage of affordability, thanks to rising home prices that have crowded out a significant portion of the population. This has made paying high rents a reality for many in the US and is just one part of an economic puzzle that gets riskier by the day. Homebuilding stocks have survived that until now, but I see plenty of reasons to conclude that the risk far outweighs the reward. Thus, my Sell rating on XHB.

Why the concern?

The biggest risk to homebuilders is likely the rapidly weakening financial position of a chunk of their customers. Lisa Abramowicz from Bloomberg summarized it well in this recent post. All of that "free money" folks received during the pandemic is spent.

The housing market is largely frozen, due to a combination of owners with low or no mortgage rates not wanting to sell what they have, and new home buyers who are looking at mortgage payments which are much, much higher than they would have been 18 months ago.

It's a stalemate. All the while, rents have surged. And while XHB was able to rally in a friendly stock market the past 10 months, the more likely case is it runs out of gas, even as demand for homes continues to stay strong. If transactions can't be completed, it doesn't matter.

A generation that might have assumed a lot of things in our economy would remain the same, that's just not how business cycles work. Here's the existing home sales chart. Looks a lot like the 2008 trend to me. This is one of many pre-recession data points that are coming at us as investors and which we need to position for.

The heat on consumers is picking up, as if persistently high inflation wasn't enough. There's also over $1 trillion in credit card debt at an average interest rate now over 20%, a combination that, by the way, is just insane, isn't it? And this month, 40 million people in the US will get their first "bill due" for their student loan payments in some time.

Jeff Weniger, WisdomTree's Head of Equities, tied this together well in a recent X (Twitter) post:

Meantime, most of the people who own their home outright and have no debt are, logically, old. Hardly anyone realizes it, but thirty-nine percent of owner-occupied US homes have no mortgage. If they choose to move, interest rates mean little to these 32.3 million households.

But interest rates mean everything to Gen X and the Millennials. Only one age group has a rising number of its members saying, "Yeah, I intend to move in the next year." Old people. They have to sell to someone, but who? Fewer and fewer youthful people plan on moving.

Of course, they don't plan on moving. They can't get approved! The typical amount of income needed to qualify for a mortgage before Covid was $42,232. Now, it is $104,016. As the Boomers sell their homes, four words describe the scene: "For sale, price reduced." end.

XHB has likely made its "round trip" and now the price looks weak

Since the start of 2022, XHB has "round tripped" from about $85 to $52 and back to a recent peak of $85 again. Many technicians would jump right up from their seats and scream, "that's a double top!" And they'd be correct. However, that is nothing without an underlying rationale that makes that double top more likely to be the end of XHB's more than 60% move in about 10 months, than a pause before breaking to new highs.

Either is possible. Technicians often get themselves in trouble when they make "100% or 0% probability" decisions.

What I see is a seriously overvalued XHB, on a weekly chart basis (more powerful a signal than shorter time frames), which happens to coincide with not only a double top in the share price but also that discouraging narrative presented in this article. That is what makes XHB a low return vs. risk outlook for me on a technical basis. Combine that with the rapidly changing housing and consumer issues noted above, and XHB gets a Sell rating from me.

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