The Housing Market Has Bottomed

| About: SPDR Homebuilders (XHB)

Living here in the U.S., one of the big questions people have been asking for a few years is: "Has the housing market bottomed or not?" I started thinking about this recently because a friend of mine from British Columbia has been looking for a home in Laguna Beach. He plans to live here during the winter months, spending the summers back up in Whistler.

After a three-month search he finally bought a house last week for just under $700,000. That's unheard of for this area. Not long ago the going price around here was at least $1 million for that kind of home. Interestingly, as his search progressed he found that the bank-owned repossessions and short sales that he had been focusing on began to dry up. Not only that, he was beginning to be outbid with multiple offers at asking prices.

Laguna Beach is an unusually affluent area and, like Canada, we never experienced the absolute depths of the housing depression that cratered areas like Phoenix, Las Vegas and Miami. Nonetheless, real estate around here still took a noticeable hit over the last few years. But now local realtors are reporting that activity is picking up dramatically and prices are beginning to creep up a little. Admittedly, an increase in activity from the very low base that has become the norm for the past two or three years doesn't say much, but it is an indicator that the market is slowly improving.

Another early indicator is that homebuilding stocks and issues like Home Depot (NYSE:HD) and Whirlpool (NYSE:WHR) have all been on fire over the last three months, clearly outperforming the broader market. Homebuilder stocks are up about 38% year to date and 85% since Oct, 1 compared to a 7% and 18% rise, respectively, in the S&P 500.

But the market is far from stable. Recent data shows that we are still seeing some decline in pricing on a national level. True, the rate of decline has slowed dramatically from a couple of years ago. As we gradually work through the foreclosure bulge related to the Robo signing settlement, the housing market should begin to stabilize and head up. Home sales have been rising, but mortgage applications to purchase the homes have not. They are down nearly 8% from a year ago - largely because lending standards still remain tight and investors are using full cash offers to give them an advantage in acquiring distressed properties.

Consumer sentiment is also improving. A monthly survey from Fannie Mae shows that people who think that now is a good time to sell rose by 3% to 13%, the highest level in over a year. However, respondents who think this is a good time to buy actually fell by 1%, though still high at 70%. Truth is, affordability is dramatically better than it was back during the peak and mortgage rates are at an historically low point.

Affordability against median income is at one of its lowest points in history. Although national home values fell nearly 25% from their peak in May 2007, current values have inched back to their late 2003 levels.

All this has begun to move the markets, but the still high unemployment rate and the large amount of housing inventory that overhangs the market means it will still be some time before we can look at a truly robust housing sector. In the meantime, the rental market continues to show strength. Many investors have benefited from investing in property stocks that focus on apartment rentals like Associated Estates Realty (NYSE:AEC) which manages over 13,000 units, or the iShares Residential ETF (NYSEARCA:REZ) which tracks a basket of 36 different REITs in apartments and senior living centres.

In light of all this, some cautionary thoughts come to mind before I get to my recommendations. First, I believe the overall market is due for a fairly significant pullback. Second, the homebuilder stocks may pull back even more given the recent run they've had.

Once this happens, then I think you can begin to build positions in the issues I'm about to recommend. If you just can't wait or if I'm wrong you can take small positions now but no more than about 25% of your final target position. This is a short-term market timing strategy. Over the longer term, 24 months or so, stocks in this area will continue to improve.

I am recommending this ETF:

SPDR Homebuilders ETF (NYSEARCA:XHB). This is an interesting basket of not only the major home builders like Lennar (NYSE:LEN), D.R. Horton (NYSE:DHI), and PulteGroup (NYSE:PHM) but also a selection of related companies such as Home Depot, Whirlpool Corp, TempurPedic International (NYSE:TPX), and Pier 1 Imports (NYSE:PIR). The units are up just over 14% over the past year compared to 5.5% for the S&P 500. Total holdings include 27 firms with roughly 30% of its assets in homebuilders and the rest in manufacturers and providers of home furnishings.

Action now: Buy XHB at $21 or less with a target of $25. The shares closed on Friday at $21.51.

Disclosure: I am long (NYSEARCA:ITB), (XHB).