Federal Open Market Committee’s impact on investments this week

Part 3
Federal Open Market Committee’s impact on investments this week (Part 3 of 7)

Must-know: Why housing starts affect homebuilders

This week’s major housing releases

This week, two major housing indicators are expected to be released—the National Association of Home Builders (or NAHB) and Wells Fargo Housing Market Index (or HMI) which released on Monday, June 16, and housing starts and building permits data released by the U.S. Census Bureau which will be released on Tuesday, June 17. Both indicators provide measures of housing starts and building permits across the U.S.

National Association of Home Builders and Wells Fargo Housing Market Index   

NAHB-HMI provides a measure of single-family home sales and their expectations, from the viewpoint of homebuilders. Based on the results of a survey of homebuilders, a seasonally-adjusted index reading is computed. A reading above 50 indicates that a majority of builders are positive about business conditions, whereas a reading below 50 indicates the reverse.

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Key takeaways from June’s report

In June, the NAHB-HMI increased by four points to 49. Good building conditions are associated with a level of 50. The index component measuring current sales conditions increased to 54 in June, from 48 in May. This is a key component of the overall HMI. Sales expectations over the next six months also increased to 59. Buyer traffic gained three points to finish at 36.

“Consumers are still hesitant, and are waiting for clear signals of full-fledged economic recovery before making a home purchase,” said NAHB chief economist David Crowe. “Builders are reacting accordingly, and are moving cautiously in adding inventory.”

The onset of spring hasn’t significantly boosted builder perceptions in the single-family, newly-built, housing market. Most builders appear to believe that business conditions are contingent on improvement in the labor market. An increase in demand for multi-family homes, such as apartment buildings, has been an important trend recently. New homeowners are showing increasing preference for apartments, as opposed to single-family homes, which is also a key factor impacting the NAHB-HMI, which looks at single-family homes data. The housing starts data for April, as released by the U.S. Census Bureau, confirms this trend.

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Housing starts and building permits

Housing starts increased 26.4% year-over-year (or YoY) in April, to a seasonally-adjusted annual rate of 1.072 million units. Housing starts for multi-family and single-family homes increased 39.6% and 0.8% month-on-month (or MoM), respectively. The increase appears to be a result of the onset of spring.

Outlook

Judging by the slow but sure recovery in the labor market, the NAHB-HMI and housing permits data releases should show mild improvement. An increase in housing activity would imply that consumer sentiment is improving and the economy is gaining traction. Also, housing acts as an economic multiplier, impacting other segments of the economy besides housing (for example—home improvement retailers like Home Depot (HD), the construction industry and mortgage financing among others). Therefore, housing starts are important leading indicators giving valuable clues to both stock and bond investors.

Sales trends in the housing market are most likely to impact homebuilders like D. R. Horton (DHI) and Toll Brothers (TOL). Investors can invest in DHI and TOL through the iShares U.S. Home Construction ETF (ITB), which tracks the performance of the Dow Jones U.S. Select Home Construction Index. The iShares U.S. Home Construction ETF (ITB), invests in homebuilders and provides a good representation of the home construction sector of the U.S. equity market.

For fixed income investors, an improvement in the economy would usually be accompanied by increases in interest rates, impacting ETFs like the Vanguard Total Bond Market ETF (BND). However, current demand conditions in fixed income markets have played an important role in determining yields. This year, despite economic improvement, yields have decreased rather than increased and most bond funds have provided positive returns. BND has returned 3.75% year-to-date (or YTD) (through May 31).

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