Housing Sector: ETF Or Stocks? (ITB, XHB, DHI)

After outperforming the first two months of the year, the home building stocks have been falling apart in March as investors begin to second-guess the housing recovery.

The 10 percent pullback in the SPDR S&P Homebuilders ETF (NYSE:XHB) from a multi-year high could either be the beginning of a sustained sell-off or simply a pullback from a high that is a buying opportunity.

Tuesday morning, the Case-Shiller Home Price Index showed housing prices up 0.8 percent month-over-month in January and an increase of 13.2 percent from one year earlier. Both numbers were pretty much in line with expectations, but that was enough to help XHB and the housing sector open higher. Also helping the optimism for the sector today is the January FHFA Housing Price Index, which rose by 0.5 percent, slightly above the estimate of 0.4 percent.

Barclays was out with a call on the sector today and they are moving from being cautious towards the group to having a more balanced outlook. The report went on to say that the outperformance this year will be more stock-specific than it typically has been. Their top pick in homebuilding is D.R. Horton (NYSE:DHI).

XHB is an interesting investment because even though it has homebuilders in the name, only 27 percent of the portfolio is invested in the homebuilders. Building products make up 28 percent, home furnishing retail is 15 percent and home furnishings are 12 percent.

A competitor of XHB is the iShares U.S. Home Construction ETF (NYSE:ITB), which is more of a homebuilder ETF. The homebuilders make up 65 percent of the portfolio, followed by building materials at 19 percent, and home improvement stores with 12 percent.

As far as performance, XHB has gained 8.5 percent in the last 12 months versus a gain of only 0.5 percent for ITB. The makeup of the two portfolios has some overlap, but for the most part investors are choosing between two very different ETFs.

When investors are considering investing in the homebuilder stocks there are a few options. First they could go with ITB, which is the closest product to tracking the companies that build homes. An investor could also opt to be a stock picker just as Barclays suggests. Or the final option is to buy a handful of stocks and build an ETF.

While the last option may be fun, it is very costly. Going the Barclays route does offer a high reward potential, but stock-specific risk will be extreme. Therefore an ETF appears to be the best option to play the housing market.

Matt McCall is the editor of ETF newsletterMarkETForceavailable at marketfy.com