Market At All Time High: What To Do Now?

by: Mike Arnold

As markets move higher and higher, it's smart to be a contrarian and question the upward trajectory of asset prices. However, it's painful to sit on the sidelines and not participate. So, how can contrarians still participate and feel secure that they are buying fractional interests in businesses at a discount to value?

One way is to focus on themes. Part of that search is finding companies/securities that fit themes which appear poised to benefit from certain macroeconomic tailwinds likely to play out favorably over time. That is, themes where the current earnings are in a trough and are poised to grow at a faster pace than the broad market over time.

As a corollary, as asset prices go higher, risk-averse, value investors must get more vigilant and search out securities that offer a wide gap between price and value. Picking themes helps set the framework for risk-averse security selection, or, stated differently, low risk, high reward opportunities.

The Theme - Housing and its Beneficiaries:

One sector that appears to fit the secular tailwind theme framework is housing and construction. According to Boise Cascade Corporation's (NYSE:BCC) most recent quarterly report, Q1 2013 total U.S. housing starts were 36% higher year-over year, while single family housing starts were up 28% year-over-year. General consensus is predicting one million new housing starts in 2013, up from 780,000 in 2012. That is significant growth, and still well below the 1.5 million average housing starts over the previous 40 years. Therefore, it appears reasonable to assume there is significant growth ahead for homebuilders, and that is just to get back to normal.

Indeed, a nice theme to believe in and follow.

The Play:

Many of the homebuilders have seen a substantial increase in their share prices, as seen in a comparative chart between the iShares Dow Jones US Home Construction Index (BATS:ITB), SPDR S&P Homebuilders Index (NYSEARCA:XHB) and the broader S&P 500 (NYSEARCA:SPY). That isn't to say there isn't value in the homebuilders, but investors may want to look elsewhere for exposure to the housing rebound.

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Top holdings for ITB (as of March 30, 2013) (source Yahoo Finance)

Top 10 Holdings (63.13% of Total Assets)
Company Symbol % Assets
PulteGroup, Inc. Common Stock PHM 9.78
Lennar Corporation Class A Comm LEN 9.74
D.R. Horton, Inc. Common Stock DHI 9.71
NVR, Inc. Common Stock NVR 7.75
Toll Brothers Inc. Common Stock TOL 7.75
Home Depot, Inc. (The) Common S HD 4.43
Ryland Group, Inc. (The) Common RYL 3.64
Lowe's Companies, Inc. Common S LOW 3.59
KB Home Common Stock KBH 3.53
Meritage Homes Corporation Comm MTH 3.21

PulteGroup (NYSE:PHM), Lennar (NYSE:LEN) and D.R. Horton (NYSE:DHI) make up about 30% of the ITB index which has outperformed the S&P 500 by a wide margin over the last two years. Investors interested in the housing rebound theme can get significant exposure to the housing cycle via ITB without picking specific stocks. Indeed, there may be better values within the sector, but the ITB allows for diversification within the theme.

Top holdings for XHB (as of March 30, 2013) (source: Yahoo Finance)

Top 10 Holdings (35.03% of Total Assets)
Company Symbol % Assets
Williams-Sonoma, Inc. Common St WSM 3.65
Tempur-pedic International Inc TPX 3.61
Select Comfort Corporation SCSS 3.57
Bed Bath & Beyond Inc. BBBY 3.56
Ryland Group, Inc. (The) Common RYL 3.49
Leggett & Platt, Incorporated C LEG 3.47
Lumber Liquidators Holdings, In LL 3.46
Armstrong World Industries Inc AWI 3.43
Fortune Brands Home & Security, FBHS 3.40
Pier 1 Imports, Inc. Common Sto PIR 3.39

The XHB provides exposure to ancillary housing rebound plays, including home furnishing companies such as Williams-Sonoma (NYSE:WSM), Tempur-pedic (NYSE:TPX), Select Comfort (SCSS), Bed Bath & Beyond (NASDAQ:BBBY) and building supply companies such as Lumber Liquidators (NYSE:LL). As the number of new homes built increase, these businesses should be beneficiaries.

As indicated in the recent stock price outperformance, the market is betting on growth in the sector.

Again, investors looking for exposure to the housing rebound, but wanting to eschew the homebuilders for its ancillary beneficiaries, XHB appears to be a reasonable proxy for certain businesses levered to the housing market.

Specific Pick - Boise Cascade:

When running a quick screen on companies expected to grow earnings at over a 25% rate over the next year and 5 years, respectively, and with a market capitalization under $3 billion, Boise Cascade (valued at $1.3 billion) popped up on the chart.

Boise Cascade Company manufactures wood products and distributes building materials in the United States and Canada, and its key competitors include BlueLinx (NYSE:BXC), Georgia-Pacific, Louisiana-Pacific (NYSE:LPX), and Weyerhaeuser (NYSE:WY).

In February 2013, Boise Cascade's private equity owners, Madison Dearborn Partners, IPO'd a partial stake in the business.

The IPO put 13,529,412 shares at $21 into the public float, netting the company $262.9 million, of which $25 million was used to pay down a revolving credit facility. The company is now in a net debt position of $16.5 million as of March 31, 2013.

Currently, public shareholders hold 31.3% of the float, while the remainder is held by OfficeMax (NYSE:OMX) and Madison Dearborn Partners. Because Madison Dearborn still holds a controlling stake in the company, they will continue to push for operational improvements as sales improve (up 27% in Q1 year-over-year) and unleash earnings leverage (reducing debt burden/expense) to increase the return on their LBO investment.

For investors looking for an operating model levered to the housing market with significant earnings leverage, Boise Cascade may be worth a look.


As markets rise, investors should become more vigilant. A rising market has the ability to lull investors to focus on return first, and risk second. However, investors should focus on the risk side of the equation first, in order to generate high, risk-adjusted returns over long time horizons. It's at precisely the time that investors forget about risk, that it is most pervasive.

I suggest picking securities that follow themes that will play out favorably over time. Even with the recent run up in security prices, a good place to start looking is at the rebound in commercial and residential construction.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.