This Boom Still Has Room to Run

The housing market has enjoyed a strong 2020...

Longtime readers know that our colleague and True Wealth editor Steve Sjuggerud has been extremely bullish on housing in recent years. And he has been right...

Sales of both new and existing homes are at or near the highest levels in more than 10 years. And home prices continue to rise. In the third quarter, the Federal Housing Finance Agency's Home Price Index rose 32% to the highest level on record.

Keeping this boom alive, homes are still "cheap" despite rising prices. It may sound counterintuitive, but it all comes down to mortgage rates. Here's how it works:

• At 3% interest, you can buy a $500,000 house with a $2,100 monthly payment.

• At 19% interest, you can buy a $125,000 house with a $2,100 monthly payment.

You can buy four times as much house when interest rates are at record lows versus when interest rates are at record highs.

Mortgage rates are still at record lows (below 3%), boosting home affordability. The National Association of Realtors' housing affordability index currently sits at 160. For comparison, a measure of 100 means a typical homebuyer has just enough to buy a home. A reading of 160 means they have 1.6 times what they need to buy... so the higher it is, the better.

Increasingly affordable homes keep pulling prospective buyers into the market, boosting sales. But with the high demand, there's a shortage of housing inventory. According to the St. Louis Federal Reserve, housing supply currently sits at 3.3 months. This means that it would take 3.3 months to sell all homes on the market at the current sales pace.

This is the lowest level for housing supply since the data began being tracked in 1963. This is a clear indication that housing supply is not keeping up with the high demand.

And to combat this, homebuilders are going to need to continue increasing construction. We're already seeing this play out...

U.S. building permits are at the highest level since March 2007. This means builders are preparing more new construction projects to get more inventory on the market. But they will continue needing to increase production to provide more supply for the market. That means more gains for today's stock...

Now, we're not highlighting a single company. Instead, we're covering an exchange-traded fund ("ETF") that provides exposure to a collection of stocks that'll benefit from a continued housing boom.

The iShares U.S. Home Construction Fund (BATS: ITB) holds 48 stocks in the home-construction sector. Its three largest holdings are homebuilding giants D.R. Horton (DHI), Lennar (LEN), and NVR (NVR). But it also holds housing suppliers like Masco (MAS), as well as home-improvement retailers Home Depot (HD) and Lowe's (LOW). These are all companies that stand to benefit from a strong housing market.

Like the rest of the broader market, ITB sold off sharply in March... But since bottoming later that month, the stock has soared. Since its March 23 low, ITB has more than doubled, and now sits near an all-time high.

Investors are getting more bullish on the housing market. We can see this play out in ITB's shares outstanding.

Funds like ITB can increase or decrease share count based on demand. If investors are excited to own homebuilders, ITB simply increases the number of shares available. And if folks want nothing to do with the sector, ITB cuts its share count.

At the bottom in March, ITB's shares fell to barely 20 million. As the fund has rallied, the number of shares outstanding has jumped about 75%. This is a signal that more investors are interested in buying up ITB shares.

But there's still room to run... ITB's number of shares outstanding is still 50% below their five-year high from December 2016... and about 5% below its five-year average. So investors' bullish attitude toward housing should continue.

The housing market's boom isn't over. And given the tight housing supply, more homes will need to be built in order to meet demand. That should fuel continued demand for new construction – sparking a further rally in ITB shares.

Sometimes investing is simple.