How To Profit From QE3, Part 2: Homebuilders

 |  About: SPDR Homebuilders ETF (XHB)
by: Alexander J. Poulos

With Thursday's surprise announcement of Quantitative Easing by the U.S. Federal Reserve a unique investment opportunity has presented itself. The Fed has decided it will attempt to stimulate the housing market specifically by purchasing $40 billion a month worth of mortgage bonds until the labor market improves. In the article below I will examine the investment case for SPDR's Homebuilders ETF (NYSEARCA:XHB). In the article below I will demonstrate the specific way in which QE3 should benefit XHB.

The Fed's aggressive actions to stimulate the housing market have begun to bear fruit. As I wrote about previously, the HAMP program has begun to positively affect the housing market by allowing underwater mortgage holders to refinance at more attractive rates. By arresting the flow of defaults, this action helped stabilize inventory and prevent further depression in prices. Once there is some firming in prices and supply this allows homebuilders to determine how much demand is out there for their products and to begin building once again.

As we can see from the link (please click it illustrates the point quite well, set it to data and range from January 1959 through June 2012) the average unit rate rarely fell below 1 million units, yet from July 2008 to current it has been significantly below 1 million units. At current levels, we are building roughly 700,000 units, which is significantly below long term averages and has been severely depressed since 2008. In my opinion the bulk of the foreclosures have worked their way into the system and have been absorbed. The will allow for stabilization of prices and allow future price appreciation.

Mortgage rates have been the biggest beneficiaries of the Fed's aggressive actions as they have fallen to lows not seen since the 1950's. As we can see from the graph embedded in this link, rates have fallen rather precipitously due to the Fed's aggressive actions. Low mortgage rates are the single biggest factor in the housing market's rebound as the affordability of a house has increased rather dramatically. The rise of rents has also added the housing rebound as the price of rents has risen rather dramatically. As the level of rent increases it will add fuel to the housing market as the largest competitor to housing (a person has to live somewhere so either they rent or buy) becomes more expensive, a purchase of a home becomes more attractive.

Chart courtesy of Bigcharts .com

XHB is an index that is comprised of homebuilding companies along with others that are directly tied to the industry. As we can see from the chart above, the outperformance compared to the SP500 has been outstanding. I highlighted this in a previous article, while the question going forward remains: can the outperformance continue?

My belief is that yes, the outperformance will continue, for two reasons. The first is the Fed aggressively targeting the mortgage market as highlighted above will cause demand to accelerate and at some point cause a shortage of homes. The second reason as shown in the link, the homebuilding industry hasn't even come close to returning to previous levels (700k versus 1million plus units per year). Until building returns to normal levels, I will remain long the XHB. I believe significant further gains will be had as the market returns to normal allowing the patient, long-term investor to reap some significant gains.

Disclosure: I am long XHB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Thank you for reading. This article is for informational purposes and not actual investment advise.