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, Blockdesk (1,790 clicks)
ETF investing, CFA, portfolio strategy, long/short equity
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Summary

  • Homebuilders are only 1/4th to 1/3rd of XHB's holdings, the rest revolve around home formations.
  • Demographics don’t stop immediately nor do their impacts.
  • Established familial trends drive continuing demand to expand housing units.
  • Shifting focus toward rentals is depressing builders, overlooking continuing demand for equipment, furnishings.
  • Market-Makers sense big-money-fund clients picking up on this opportunity, see likely ETF price gains near-term, better than other ETFs, and overall market.

Ducking the boomerang

What happens when the head of an empty-nest retires, or gets laid off? Unless the nest is well-feathered, he (and she) downsizes, conserving resources. If they are like many, their 401-k mutual fund investments haven't grown much over the years, and now-instant financial planning takes stage-front. The now too-big family pad is a (unfortunately, somewhat-reduced, but available) source of liquidity, and a move into reduced quarters may eliminate remaining mortgage payments. This may be a partial explanation of the current high percentage of home purchases being for cash.

When the kids, lucky to get a job, find themselves priced out of what used to be a low downpayment first-home market by for-cash purchasers, they must, for starters, turn to a rental. The ones without jobs come back from college (with big debts) to find that their former bedroom has mutated first from a home office and job-search center, to being owned by someone they never met, who has his/her own needs. Maybe dad can help with the rent money.

Unpleasant as it may be for many in this 300-million country, home ownership has become a luxury enjoyed by a smaller proportion of the population. Renting is where the action is. And all those units need refrigerators, laundry facilities, beds, drapes, rugs, and the other necessities.

So where is the opportunity?

For the producers of that stuff it may be more profitable and efficient if the landlord pays for it and packs its cost into the monthly rent. So Whirlpool (NYSE:WHR), Tempur-Sealy (NYSE:TPX), and the rest of the home-furnishing community get their deserved share of the demand revenues. And Home Depot (NYSE:HD) and Williams-Sonoma (NYSE:WSM) know how to pick up the crumbs (?) from the ongoing relocations.

That reasoning has percolated up into the investment-researching community and is putting support into the stocks that serve this segment of the housing business, and are among XHB holdings.

What is running counter to those positives is a continuing flood of (only sometimes believable) government statistics most easily grasped by observers just at the surface level. Much of that reaction is in the form of waves of elation and despair, with investors hoping for signs that the "good ol' days" will soon return.

Where are we now in that cycle?

In the despair phase, apparently. Good (for us).

Ask any experienced shopper. The time to buy things is when they're on sale. When they are truly marked down from prices at which the goods actually changed hands. (Not like so much of the retail hoopla.)

Fortunately investment transactions are carefully logged and watched. Here is what shows for the SPDR Homebuilders ETF (NYSEARCA:XHB) as prices and Market-Maker (MM) coming price-range expectations during the past 6 months.

(used with permission)

Those heavy dots are end-of-day [eod] market quotes. The vertical lines are MM forecasts of likely coming possible prices for XHB, derived from the hedging actions needed to protect MM capital put at risk to complete big-money-fund client volume trade orders.

The eod prices split the forecast ranges (made the same day) into upside and downside prospects. Our measure for that split we call the Range Index (RI), which reports what percentage of the range lies below the eod quote. The smaller the RI, the better the upside prospect.

As current events evolve, competition changes, alternatives become more or less attractive, prices and expectations change and so do Range Indexes. Experience shows that the RI level of most widely-held and actively-traded investments has useful price-forecasting capabilities, on a subject by subject basis.

Here is what the past 4-5 years has produced following its Range Index daily at various levels, in terms of price changes (at an annual rate) during progressively longer holding periods up to 16 weeks (near 4 months) of 80 market days.

(click to enlarge)

The table shows average price change results at levels of Range Index experiences, cumulated from the top and bottom rows to an overall set of figures in the blue line row at the middle. The #Buys column tells how many observations are in each row. The magenta-colored 15 signifies where the RI is currently.

Pretty clearly, RIs under 29 have provided very attractive buying opportunities for XHB. A buy and hold during these 4+ years, regardless of the date of purchase, would have produced about a 19% to 20% annual rate of price gain. Below 29 RIs offered rates at 5 to 6 times that average rate. Below 29 is where XHB is now.

Before leaving this, please take a minute to appreciate how impossible it is, using this table, to lie about what has happened to a subject. Every market day of the 1130 between 11/11/09 and 5/15/14 has been included. So no cherry-picking of beginning or ending dates can go on.

The inclusion of holding periods from as short as 5 days to almost 4 months shows how robust the measurements are across holding time involvements. Most results changes are rather gradual in their appearance and decay. We can't get away with highlighting sudden spikes of price change to build a misleading presentation of what might be expected.

Likewise, the accumulation of RI groups avoids any distortions attributable to just a few experiences accidentally occurring in a narrow set of RI values. Everything here is designed to build credibility in what the table shows, good or bad. This one is good, but that is no guarantee that future price changes will duplicate the past.

How to use what we now know

It looks like this XHB instance can be a sure money-maker, but nothing in equity investing is ever for sure. So we have a standard test procedure to see how good the forecasts of MMs have been for each specific investment subject. We apply the same standard to all of them, as well as the one of most current interest.

Here's the test: Use the MM (or any other) coming price range forecast's top expectation to set a sell target. It should cause a closeout of the holding (created on the market day after the forecast) on the first day's close after the target is reached. If the target never gets reached in 3 months (63 market days) after the forecast, the holding is closed out, regardless of any other information that has appeared in the interim, and despite any gain or loss created by the action. No other sell rules are invoked. The test is simple and after-the-fact judgment-free.

We keep score, updated daily, on this basis for each of the 2,500+ widely-held and actively traded stocks and ETFs currently measurable. Here is what the test produces for XHB currently, in comparison with the market-proxy of SPY, half a dozen best-ranked ETFs, all ETFs with current forecasts, and the entire population of all stocks and ETFs with currently available forecasts.

(click to enlarge)

A quick explanation of the less-obvious numbered columns: (5) is the percent change between (4) and (2). (12) tells, out of the total number of forecast days available, that sample number of those days with Range Indexes like the present. The Range Index (7) is the percentage of the forecast range (2 to 3) that lies below the forecast day market price (4). Using the prior sample in (12) to follow a standard, simple time-efficient holding discipline, (8) indicates the percentage of them that were profitable, (9) the average net gain on all such holdings, (10) tells how long on average the samples were held, and (11) the rate created by (9) and (10). (13) measures the credibility of (5) given (9), and (14) compares (5) to (6).

Please invest the time and effort it may take to understand the dose that is inflicted by all of those data points in the prior paragraph. The data does provide a useful way to compare some not-so-simple, but realistic, investment considerations.

For example, the critical starting point in each is the benefit being offered by each forecast in (5), larger for XHB than for SPY. Past experiences of (9) say XHB's +11.7% is far more credible than SPY's or either of the larger populations, both of which are the least believable. Credibility underlies the reward to risk ratio, faulting the overall population's apparently optimistic bias. We regard that as a conservative bent by the MM community to avoid getting hurt from being short stocks while providing market liquidity

Looking specifically at the data for XHB, the standard test procedure described in paragraphs above the table had 11 prior RI forecast-day experiences to work from, fewer than we prefer, but still an adequate number to reflect upon. All of them produced gains, which is encouraging, but no guarantee.

The distribution of XHB Range Indexes during the 5 years of our test shows that in an orderly, compact array of valuations, the current one at 25 has very few priors more extreme or likely to be better.

The +15% average gains from the test surpassed the current upside forecast of under +12%, adding credibility to the current outlook. The average 40 market-day holding period (2 months) compounds the achieved gains into a +150% annual rate, which should be taken as providing perspective, not a target or guarantee. XHB's worst-case price drawdown experiences of less than -6% are not even half of the upside prospect, producing a reward-to-risk ratio of over 2 to 1.

Overall, the XHB prospects and test results offer a far more attractive proposition than the SPDR S&P 500 Trust ETF (SPY) market proxy, and is well above the large-population prospects.

Conclusion

In a period of considerable investment commentary apprehensive of equity investment risk, XHB provides the prospect of quite attractive price gains despite the market's gyrations. MM forecasts imply that big-fund money is moving into the ETF and should result in both defensive strength and opportunistic benefit in the near term.

Source: The SPDR Homebuilders ETF: An Attractive Investment-Defensive Vehicle For Hidden Reasons