Over the past two years, few if any sector ETFs have rivaled the iShares Dow Jones U.S. Home Construction Index Fund (NYSE:ITB) and the SPDR S&P Homebuilders ETF (NYSE:XHB). Since April 26, 2011, ITB and XHB have returned an average of almost of 75 percent, or better than triple what the SPDR S&P 500 (NYSE:SPY) has offered over the same time frame.
Along the way, there have been ample calls saying that ITB, XHB and their constituents were overbought and that the homebuilder rally was getting long in the tooth. While these ETFs certainly did not move up in a straight line, the charts indicate that every legitimate dip over the past 24 months has been a credible buying opportunity.
Continue Reading Below
Despite all the ebullience, S&P Capital IQ sees risks looming for ITB and XHB.
"In short, while we do expect continued improvement in the housing market in 2013, we think there are several factors that could derail this recovery," said the firm in a new research note. "Briefly, in terms of demand, weakness in the labor market and the burden of student loan debt has impeded household formation. In fact, despite record low interest rates boosting affordability (a byproduct of the Federal Reserve's easy money policy), there has been a dearth of first-time homebuyers - a group we think is needed for a more sustainable recovery. Instead, recent demand has been bolstered by investors, who tend to be fickle and highly sensitive to changes in interest rates."
Year-to-date, ITB, the smaller of the two ETFs with $2.33 billion in assets under management, has soared 15.5 percent. XHB, which has $2.77 billion in assets, is up 14.8 percent.
As has been previously noted, ITB and XHB go about their business differently. XHB is home to 37 stocks with none receiving a weight in excess of four percent. Additionally, this ETF is more leveraged to the discretionary side of real estate with holdings such as Bed Bath & Beyond (NASDAQ:BBBY) and Williams-Sonoma (NYSE:WSM). Only four of XHB's top-10 holdings are pure-play homebuilders.
While ITB does feature some exposure to the likes of Home Depot (NYSE:HD) and Lowe's (NYSE:LOW), the ETF is the more direct approach to homebuilders. For example, DR Horton (NYSE:DHI), Pulte (NYSE:PHM) and Lennar (NYSE:LEN) combine for about 30 percent of the ETF's weight.
Beyond specific holdings, S&P Capital IQ sees risks regarding delinquent mortgages. Citing Lender Processing Services, the research firm said: "There are still 5.1 million properties that are either 30 days or more delinquent on their mortgage or in the process of foreclosure, representing 6.8% of all mortgage loans in the country. This includes 1.69 million homes that are currently in some stage of foreclosure, nearly matching the 1.93 million homes that the National Association of Realtors says were available for sale in March."
Adding to the potentially dangerous situation for ITB and XHB is rising foreclosures could cap upside for home prices while meaning a flood of new inventory could come to market.
"Rising home prices could cause banks to release their foreclosed properties from their inventories at a faster rate, and could also allow many underwater homeowners the chance to sell their homes. As a result, we think there will likely be a ceiling in terms of how fast prices can rise, because it will induce more supply to hit the market," according to S&P Capital IQ.
Important technical levels to watch on ITB would be $23 and $21 on the downside. For XHB, the chart shows $28 and $26 as prominent support areas. S&P rates ITB Underweight and XHB Marketweight.
For more on ETFs, click here.
(c) 2013 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.