Promise of Stimulus Lifts PowerShares Building & Construction ETF

 |  Includes: CAT, DY, FLR, HD, JEC, LOW, MHK, MLM, MTZ, NVR, PKB
by: Don Dion

After dipping to a 52-week low in late November, PowerShares Dynamic Building and Construction (NYSEARCA:PKB) rallied quickly in December, proffering a 36.2% return in the last month. While the fund’s returns are still down nearly 40% year to date, recent portfolio adjustments and the promise of a new public works agenda by the incoming administration have helped the fund gain momentum in recent weeks. As of December 16, PKB held the No. 59 spot in our Sector Momentum Tracker rankings, improving from its No. 75 position on November 25.

PKB tracks the Building & Construction Intellidex Index. Components of the index have to meet a variety of criteria: fundamental growth, stock valuation, investment timeliness and risk factors. PKB’s index is composed of 30 U.S. building and construction companies. These companies provide construction and engineering services for the building and remodeling of residential, commercial and industrial properties. Some of the included companies also engage in large-scale infrastructure projects.

PKB is rebalanced on a quarterly basis, and since Sector Momentum Tracker last reviewed the fund in August, four out of the top 10 components have changed. Since August, Quanta Services (NYSE:PWR), Manitowoc (NYSE:MTW), NCI Building Systems (NYSE:NCS) and Terex Corp. (NYSE:TEX) have all lost their place among PKB’s top 10 components, with PWR, MTW and TEX losing their place in the index altogether. The removal of these components has cleared the way for top 10 additions like Martin Marietta Materials (NYSE:MLM), Home Depot (NYSE:HD), NVR Inc. (NYSE:NVR) and Dycom Industries (NYSE:DY).

The addition of four new stocks to the index has benefited PKB investors through exposure to companies that are holding up comparatively well during the economic downturn. Despite its recent weakness, Dycom has contributed to the U.S. telecommunication infrastructure and to contracting services for construction and engineering projects for more than 40 years. A component like this—which has demonstrated endurance through other economic downturns—could be a good addition to U.S.-based PKB.

Home Depot (HD), now the fourth-largest holding in PKB, experienced a bounce upon news of the latest rate cut. HD had lost steam in 2008 as current homeowners cut back on renovations and new homeowners found it increasingly difficult to procure loans. As the Fed cut rates to near zero, shares of HD reacted to the news with a rally. MLM, now the third-largest component in PKB, is a favorite analyst pick to benefit from a federal infrastructure program. The North Carolina aggregates producer could see more business with a federal plan in 2009, a move that would benefit PKB’s investors.

PKB’s current top holding, Mohawk Industries (NYSE:MHK), has been in the fund for the long haul in 2008. Since August, MHK has grown to represent a larger portion of the PKB portfolio, shifting from 4.36% of assets on August 1 to 6.40% of assets on December 19. MHK’s business is concentrated, and the company focuses on the production and sale of floor covering products for residential and commercial use in the U.S. and Europe. Cowen and Company upgraded shares of MHK from neutral to outperform on December 15, noting that the recent decline in oil prices and inventory reductions could boost free cash flow in 2009. MHK investors have rallied around the stock in recent weeks, believing that MHK’s 49% decline in Q4 of 2008 represents a turnaround point for the company.

Investment in a smaller sector fund like PKB inherently carries more risk than a larger, broader approach. PKB’s index includes a range of different-sized firms, and investors’ exposure to smaller-cap companies through the fund will also add investment risk.

The greatest challenge when investing in PKB, as with many ETFs, is that the low trading volume in the fund will lead to illiquidity and price dislocation. In the last three months, only 44,000 shares of PKB have traded per day on average, an indication that investor interest in the fund is relatively low. Volatility in PKB seems to peak during opening and closing trading periods, so it may be wisest for investors to trade the fund in smaller lots during the middle of the trading day.

Despite a notable lack of volume and subsequent liquidity concerns, PKB’s index has shown remarkable strength during an otherwise difficult period. Changes to the index in recent months have helped PKB’s investors garner returns and have also helped the fund steadily increase its momentum in our rankings. As smaller investors approach the new year looking for more conservative sector opportunities, PKB could provide a profitable addition for some portfolios.