Back in early June, Investing Daily’s Ben Shepherd wrote that the residential real estate market had bottomed but that there was not yet convincing evidence that an upward recovery in homebuilding had begun. The distinction between a “bottom” and a “recovery” is important because stocks typically only go up if future business prospects are better than the present, not just the same. Without a genuine recovery, housing stocks are likely to be nothing more than dead money.

If you want to see what a dead-money stock looks like, check out the price performance of stocks that recently received that uncomplimentary moniker from me, such as Google (NasdaqGS: GOOG) in January and Bed, Bath & Beyond (NasdaqGS: BBBY) in June.

Since late May, when Chad Fraser first wrote about a housing market rebound, housing data has gotten stronger and I can now confidently state that housing has not just bottomed, but is experiencing an actual recovery! Consider the following data points:

• Housing starts in June rose 6.9% sequentially from May and were up an even more impressive 23.6% year-over-year. They are now at the highest level since October 2008 (almost four years)!
• Construction of single-family homes in June rose 4.7% sequentially from May, the strongest number since April 2010
• Homebuilder confidence in the strength of the single-family housing market rose six index points in July to its highest level since March 2007 (more than five years). The six-point monthly gain was the largest since September 2002 (almost 10 years ago). According to David Crowe, Chief Economist for the National Association of Home Builders:

Combined with the upward movement we’ve seen in other key housing indicators over the past six months, this report adds to the growing acknowledgement that housing – though still in a fragile stage of recovery – is returning to its more traditional role of leading the economy out of recession. This is particularly encouraging at a time when other parts of the economy have begun to show softness.

• According to Stuart Hoffman, Chief Economist for PNC Financial (NYSE: PNC), the housing market will contribute to U.S. GDP growth in 2012 for the first time since 2007. Housing will be even stronger in 2013 and Hoffman expects it to “lead economic expansion over the next two years.” Wow, what a turnaround!
• In the July 18^th release of the Federal Reserve’s beige book, housing was the only market segment that showed positive growth in all 12 Federal Reserve banking districts.
• Home prices, as measured by the S&P/Case-Shiller Index, rose in April for the first time in seven months. None of the top 20 U.S. cities posted new price lows in April. Despite the April price rise, home prices remain near March’s 10-year lows, but David Blitzer of S&P labeled the April price rebound “a good sign.”
• Low home prices combined with the lowest 30-year mortgage rates on record make housing affordability better, but a June 2012 academic study argues that tighter home mortgage lending standards (e.g., higher down-payment requirements) have counteracted most if not all of the benefits of lower prices and lending rates.

The stock market is a great anticipator, so housing stocks have already risen quite substantially this year. The SPDR S&P Homebuilders ETF (NYSE: XHB), which is equal weighted with a 30% allocation to pure homebuilders, has almost tripled the 9% return of the S&P 500 index (26.2%), and iShares Dow Jones U.S. Home Construction ETF (NYSE: ITB), which is capitalization-weighted with a 65% allocation to homebuilders, has done even better (43.6%):

 Source: Bloomberg

One reason the ITB has performed so well is that it holds a 10% position in Lennar (NYSE: LEN), one of the largest U.S. homebuilders and a company that is doing very well. In a June 27^th conference call after second-quarter earnings, Lennar CEO Stuart Miller stated:

I’ve noted over the last few quarters that we’ve been seeing consistent improvement in both traffic and demand activity in our communities. This has acted as confirmation that both the housing market and the overall economy are stabilizing and that a very real trend is beginning to take shape. As I look ahead to the remainder of this year and towards 2013, I am increasingly optimistic that we are seeing a real bottom in housing and that we will continue to see signs of recovery.

CEO Miller’s optimism is mirrored by Standard & Poor’s, which upgraded Lennar’s credit rating from “stable” to “positive” based on improving fundamentals – to wit, that “Lennar is likely to post consistent net operating profits over the next two years.”

Here at Investing Daily, we’ve written positively about Lennar a couple of times, once in March 2010 and once this past January, and anyone who acted on our positive evaluation has done well. The question is whether homebuilders are still the best place to invest in the housing-related stock universe. I would think not, given that their strong outperformance has already taken place. It’s wise not to invest looking in the rear-view mirror.

Rather, the best housing-related investment opportunities are probably those housing segments that haven’t rebounded strongly yet. Looking at the non-homebuilder names in the SPDR S&P Homebuilders ETF, a few retail stocks that look attractive at current low valuations include:

• Home Depot (NYSE: HD)
• Lowes Companies (NYSE: LOW)
• Pier 1 Imports (NYSE: PIR)

If you want to play the momentum game and keep a few homebuilders in your portfolio, simply buying XHB is another possibility, but I would stay clear of the homebuilder-heavy ITB.

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