Equity investors often overlook market seasonality. Unfortunately, seasonality is usually tied to future markets. However, there are instances where the seasonality of commodities can enhance an Exchange-Traded Fund (ETF). Two significant commodities are entering a seasonal buy that will impact an outperforming homebuilder ETF. The Federal Reserve (FED) appears ready to begin a new cycle of lower rates, which may catalyze this ETF seasonal pattern.
Pros and Cons of the Current Housing Market
The housing market has been on a tremendous appreciation path. One thing is for sure: the US will always have demand for housing. With this demand comes opportunities for ETF investors if they know seasonal lows in the new home construction season.
2024 was a lackluster year for existing home sales, but many builders profited well with new home sales. One way builders enticed buyers was by offering incentives. Some of these incentives involved creative financing to make the homes more affordable.
After a long-awaited period, the FED has pivoted from a higher rates cycle to a lower one. The recent FED meeting expected a rate cut, but how much? What seemed surprising was that 50 basis points were cut to start a new cycle, but many analysts had predicted only a 25 basis point cut. Newswires claim that the market had priced in the cut before the meeting and that there may not be any more room to go lower. But if the market was caught off guard by such a large rate cut, how could the market have priced in 100% of the cut before the FED meeting? This may open the door to more easing in the mortgage rate sector.
Another interesting fact is the pent-up demand for home purchasing. The housing market has had very little inventory for a couple of years. Some of the reasoning is the affordability of purchasing another home if a previous owner did sell. Another idea was that many home buyers locked in sub-par 3% rates would not sell their homes and face higher mortgage payments with the 8% mortgage rates we recently witnessed. Do you remember people were locked up and restricted from going out during Covid? After the pandemic ended, there was so much pent-up energy that they bought everything imaginable. The weak housing market has put a similar restriction on homeowners. Americans are known for not staying in their homes for long periods. Money market funds are at all-time highs, and when the spring home-buying season comes, money is likely to flow out into lower-rate mortgages and more supply coming to market as home buyers escape the recent "lockdown."
Currently, mortgage rates hover around 6%. Some home buyers only remember rates being less than 3%, and this caused a problem when buying at higher rates, like 7 to 8%. However, many of us remember rates in the 16-18% range, and a single-digit mortgage is considered gold. Home buyers slowly accept that the new rate norm might be 5-6%, making them more comfortable buying a home. The more time the rates hover in the 5-6% range, the more relaxed buyers will become. Rates below 3% will only be seen again if another catastrophic event, such as the pandemic or a housing market crash, where the FED will be forced to buy mortgages to significantly lower long-term rates again.
Two Significant Commodities for the Home Building Industry
Homes require approximately 400 pounds of copper to build. Lumber is needed to construct the homes as well. Both of these commodities put in a seasonal price low in the October timeframe. During this time, home builders and supply companies (pipes and electrical wiring) purchase contracts for delivery, as building supplies tend to be the least expensive during October, unlike buying them in the spring when demand and prices are higher for the same products.
Source: Moore Research Center, Inc. (MRCI)
MRCI research reveals the 15-year average of copper prices tends to make their seasonal lows (black line) in October and then rally strongly into the beginning of the spring building season.
Traders could use the copper futures market HG contract or the micro-contract QL to participate in the seasonal rally.
Source: MRCI
MRCI research reveals that the 15-year average of lumber prices tends to make their seasonal lows (black line) in October, just like the copper market, and then rally strongly into the beginning of February or March.
Traders are urged "not to use" the futures market LB contract due to the meager daily volume, which leads to extreme chances of price slippage.
It's important to note that while seasonal patterns can provide valuable insights, they should not be the sole basis for trading decisions. Traders must consider other technical and fundamental indicators, risk management strategies, and market conditions to make well-informed and balanced trading choices.
Source: Barchart
For investors, the SPDR S&P Homebuilders (XHB) ETF would be the most practical vehicle for participating in the upcoming seasonal pattern. Viewing the chart, I've highlighted the past five years of the XHB ETF with the same October (green arrow) to February (red arrow) period as the copper and lumber market. During the past five years, the XHB ETF has returned a solid 79% return, impressive results considering the recent run-up in interest rates and inflation. With lower rates on the horizon, could we see higher prices?
State Street Global Advisors manages XHB and seeks to track a modified equal-weighted index, which provides the potential for unconcentrated industry exposure across large, mid-, and small-cap stocks. The expense fee of .35% is reasonable for such market diversity. The year-to-date (YTD) has been 27%, and the past five years was 79%. The average daily volume is approximately 1.8-2 million shares.
In closing…..
The current housing market landscape presents a unique opportunity for ETF investors, particularly with the upcoming seasonal lows in crucial commodities like copper and lumber. As the FED shifts towards lower rates, the SPDR S&P Homebuilders ETF (XHB) stands poised to benefit from this dynamic, potentially unlocking significant returns. While the housing market has faced challenges, the underlying demand remains robust, supported by the historical resilience of the US housing sector. As we approach the spring home-buying season, savvy investors should consider seasonal patterns and broader market trends to make informed decisions that capitalize on this promising environment.
On the date of publication, Don Dawson did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
