The best way to profit as the US housing recovery continues

The financial crisis in 2008 was the inevitable result of years of overly-low interest rates and careless lending. But the trigger for the collapse was the bursting of the US housing bubble.

Between 2000 and 2006, US house prices shot up by nearly 90%. Then the bubble burst. By 2011, when they bottomed out, US prices had dropped by a third. Factoring in inflation, they fell by over 40%.

It was painful – a lot more so than anything we experienced in the UK. But the fall did its work. Banks had to write down their bad loans, allowing people to start again. Low prices eventually tempted others back into the market.

As a result, prices have rebounded by 15% in the last two years. And shares in house builders have soared.

That’s led to talk of a brand new bubble. We think that’s a little premature – there’s life left in the US housing recovery. But there are now better ways to play it than through the building sector.

Here’s one suggestion.

US property prices are rebounding – but we’re not back in bubble territory

The rebound in US house prices has led to fears that history will repeat itself. Critics have pointed to double-digit annual price rises in markets like California as evidence of a new bubble.

And concerns about rising mortgage rates have taken some of the froth out of the construction sector. Shares in US home builders have fallen by about 10% from their peak in May.

But while certain regions might be a bit over-heated, US property is on average still pretty cheap. In real terms (adjusting for inflation), national prices are stuck where they were in 2001. And total US spending on housing and cars as a percentage of GDP remains at record lows (for the post-war period).

The threat of a wave of foreclosures – which has long hung over the market is – is also starting to go away. The share of mortgaged homes in negative equity (where a household has a mortgage bigger than the value of the house) has fallen from one in four to around 14%.

As a result, distressed home sales now account for less than 15% of total sales, compared with 50% in 2009.

At the same time, there is a lot of potential demand. During the financial crisis, ‘millennials’ (those in their 20s and early 30s), were hit hardest as firms stopped hiring and adopted ‘last in first out’ policies.

That meant many were forced to move back home to save on the rent. Figures suggest that a third of this generation now live with their parents. But as the economy perks up, and the unemployment figures improve, they will be keen to move out and buy their own homes.

The latest figures suggest that the US economy is growing at an annual rate of around 2.5%, and this is expected to improve to 3% by the end of the year. Meanwhile, unemployment is down to 7.2%, from 9% two years ago. This should boost people’s confidence and buying power.

Of course, the big worry is what happens when the Federal Reserve starts to wind down its money printing. Already mortgage interest rates have risen sharply to 4.9%, compared with an average of 3.9% throughout last year. This is one reason why the shine has come off house builders’ stocks since May.

However, it’s now looking as though the Fed will move extremely slowly on tapering. Firstly, the Fed’s surprise decision to avoid cutting back in September shows that it’s in no real hurry to do so. And the appointment of ‘dovish’ Janet Yellen to succeed Ben Bernanke suggests this will continue.

Overall, Alexandre Tavazzi of Pictet Wealth Management thinks tapering won’t begin until early next year. And even then, the Fed will only take baby steps in doing so. That suggests the housing recovery won’t be threatened by any sign of rising rates until well into next year.

How to play US property now

So how can you profit? The most obvious way to take advantage of rising house prices and a strengthening economy is through house building stocks, which we’ve tipped in the past. But while they have dipped back since May, they have not become desperately cheap. Indeed, the main exchange-traded fund tracking the sector trades at a price/earnings ratio of 18.

A better way to take advantage of the housing recovery is through the durable goods sectors. Durable goods are items, like kitchens and televisions, which are kept for relatively long periods. They are often bought at the same time as people move into a new house, so increased home sales should boost consumption of these goods.

One of the best companies is Whirlpool (NYSE: WHR), which makes large domestic appliances, such as washing machines, fridges, showers and baths. While it is a global company, it gets around half its revenue from North America, where sales are expected to grow by around 4-5% for the next few years. JP Morgan thinks that it is on course to boost operating margins in the region from 10.2 to 12.2% – which should further boost profits. Overall, it trades at only 12 times 2014 earnings.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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Merryn

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