PowerShares Dynamic Building & Construction Finds Pockets of Growth

While dismal news is still emanating from the housing industry, PowerShares Dynamic Building & Construction ETF(PKB) has managed to gain momentum on our Powershares Momentum Tracker sector ranking, due to several key components.

The housing slump has been tied in closely with the banking crisis that has plagued the U.S. economy during the past year. The number of mortgages has seen a 10%-20% increase over the last few years, and as the value of homes drop, people left holding these mortgages have experienced negative income.

The issue of surplus inventory has driven down the share prices of many home builders. On Monday, Aug. 4, WCI Communities Inc. (WCI), chaired by Carl Icahn, filed for bankruptcy. With Moody’s Investors Service predicting that June’s 2.4% default rate could rise to 5.4% by December, WCI may not be the last construction company to see its shares plummet.*

While WCI is not among PKB’s 30 components, PKB has certainly felt pressure from negative industry news over the past year. On Dec. 24, 2007, PKB’s share price held at 18.77, before falling as low as 16.48 one month later. PKB has picked up the pace over the last month, however, with share prices rising more than 4% from July 8 to Aug. 4. PKB has also made significant strides up our PowerShares Momentum Tracker sector ranking, moving from the 46th spot on May 7 to the 34th position on July 30.

The key to PKB’s heartiness in difficult markets lies in its methodology and components. PKB is designed to track the Building & Construction Intellidex Index. Components have to meet a variety of criteria: fundamental growth, stock valuation, investment timeliness and risk factors.

One aspect of PKB’s strength can be attributed to the fact that the fund is not solely concentrated in the housing sector. PKB’s top 10 holdings include home improvement giant Lowe’s (LOW), construction equipment manufacturer Caterpillar (CAT) and capital equipment manufacturer Terex (TEX).

TEX has certainly helped to support PKB’s price in recent weeks. With a $4.7 billion market cap and three-year earnings per share growth of 37%, TEX’s bargain price might spur investors to scoop up shares. In its earnings call on July 24, CEO Ronald M. DeFeo announced that “Terex had an outstanding quarter and first half. For perspective, net income in the January through June 2008 period was about $400 million. This is equal to net income for all of 2006.” The earnings call also revealed that strength in its crane manufacturing, materials processing, and mining will offset losses in construction. TEX, like PKB itself, has tried to diversify itself across the industry in order to soften the blows of any particular industry slowdowns.

CAT could also benefit from its well-diversified business model in the future. As PKB’s fourth-largest holding, CAT will certainly benefit from continued growth in emerging markets. As emerging economies begin to develop infrastructure solutions, CAT hopes to expand its presence in these markets. Another factor that may boost CAT’s price in the future is the demand for alternative energy solutions. CAT has established operations in some of the locations where drilling is being considered, such as northern Canada, so a shift to drilling in new locations could mean increased profits for a company like CAT.

PKB’s largest holding is Quanta Services Inc. (PWR). On July 16, JPMorgan added PWR to its Focus List. JPMorgan stated that it believes that increases in wind energy development in the U.S. could mean strong earnings leverage for PWR over the next five years. PWR has already gained more than 12% year to date as of Aug. 5, and could benefit more if plans—like the one presented by T. Boone Pickens—call for the construction of more windmills.

It is important to remember that PKB is a lightly traded ETF with a concentrated portfolio. With a $19.2 million asset base and only 30 components, this fund may not be appropriate for some investors who are looking for more diversity. PKB also places 42.66% of its assets in the top 10 holdings, a move that makes the fund more apt to fluctuate with the price of one top holding.

PKB’s allocations outside of strictly housing have helped the fund outperform other housing indices. PowerShares’ website shows PKB’s index outperforming the S&P Super Composite Construction & Engineering Index by 12% and the S&P Super Composite Homebuilders Index by 59% as of Aug. 4, 2008.**

While the housing market may struggle during the recovery process, some investors believe that now could be the time to invest in housing construction. An ETF such as PKB, whose components are diversified, may boost returns for patient investors.

*Source: Bloomberg.com
**Source: PowerShares.com