XHB SPDR S&P Homebuilders

Revised U.S. GDP data of 3.6% for Q3 against 2.8% predicted earlier, a reduction in jobless claims, better-than-expected data in non-farm payroll numbers and a continued surge in manufacturing numbers renewed the taper concerns all over again in early December.
 
While this economic good news may spread cheer within the nation, some corners of the investment world, such as the homebuilding sector, will likely be hit by this bullishness. The sector has been a star performer so far this year courtesy of historically low interest rates, but might falter in the coming days owing to the rising rate concerns (read: The Comprehensive Guide to Homebuilders ETFs).
 
Why Homebuilders are Worried
 
High interest rates make mortgage loans more expensive which in turn weakens the demand for new homes. The prospect of tapering has started to push up interest rates. According to the Freddie Mac mortgage survey, the 30-year fixed mortgage rate moved up from 3.59% on May 23 to 4.46% on December 5.
 
In fact, the rate edged upward by 24 bps within just 15 days in December following a slew of positive economic data. Both existing and pending home sales declined 3.2% and 0.6% respectively for the second successive month in October.
 
Quite expectedly, the data penalized the homebuilding ETFs. The three funds tracking the sector – iShares Dow Jones US Home Construction ETF (ITB), SPDR S&P Homebuilders ETF (XHB) and PowerShares Dynamic Building & Construct (PKB) – have all seen weakness over the past few trading sessions, and continue their slump if rates soar higher.
 
What to Expect from the Sector?
 
Notwithstanding all concerns, the sector is poised to stay afloat even if the Fed tapers, in our opinion. The following reasons explain the prospects in the sector.
 
Interest rates are still well below average levels, keeping housing still reasonably priced. Also a better job market and improving consumer confidence from the lows it witnessed two years ago are encouraging consumers to purchase new homes.
 
Plus, home inventories remain tight. A scarcity of land and labor is restricting the construction of homes, both single and multifamily. As a result, lower housing inventory and a still-steady demand profile are raising the price of properties.
 
The new home sales data bounced back in October following a year-low plunge in September. By now, buyers are presumably immune to the ups-and-downs in mortgage rates.
 
In short, there is still a considerable amount of pent-up demand in the homebuilding sector that can pull it through the coming days (read: 3 Homebuilder ETFs Leading the Pack this Earnings Season).
 
Conclusion

Even though a sword of Damocles hangs over the head of the sector with the imminent taper, we really do not believe this is something to panic over. Builder confidence in the market for newly built, single-family homes did not deteriorate further in November.
 
Forward looking projections are pretty assuring. As per the National Association of Homebuilders, both single and multi-family home sales will likely rise at around double the pace in the coming year and the year after from 2013.
 
In fact, an expected 76 bps and 86 bps rise in fixed mortgage rates in 2014 and 2015, respectively, are not expected to hold back the housing recovery. Prime rates are guided to stay the same next year and nudge up 5 bps in the next, so concerns may be limited for the long term.
 
Most homebuilders believe the housing momentum will continue into 2014. Bearing these in mind, the ETF outlook on the sector also appears promising. Presently, ITB has a Zacks ETF Rank #2 (Buy) and XHB and PKB carry a Zacks ETF Rank #3 (Hold) (see more ETFs in the Zacks ETF Center).
 
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ISHARS-US HO CO (ITB): ETF Research Reports
 
PWRSH-DYN BLDG (PKB): ETF Research Reports
 
SPDR-SP HOMEBLD (XHB): ETF Research Reports
 
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