A smart investor recognizes that the market is a forward-looking beast. He also knows that the market regularly scales "walls of worry," and that prices rise before everyone realizes a recovery is imminent.
The average investor? Well, he sits on the sidelines and, in turn, misses out on significant profits.
Don't believe me? Look no further than the real estate sector for proof…
Be Greedy When Others Are Fearful
Back in February, when I predicted the real estate market hit rock bottom, my inbox overflowed with venom for making such a preposterous claim. Hundreds of readers unsubscribed, too.
Of course, homebuilding stocks were already telegraphing a recovery. But nobody wanted to believe it because home prices were still falling across the country. They let the "wall of worry" blind them from the opportunity.
As I wrote at the time, though, "prices are going to be the last thing to bottom out." Well, they just officially did.
The latest reading of the Case-Shiller House Price Index went positive on a year-over-year basis for the first time in 21 months.
Now that people can finally see the real estate recovery, they're starting to believe it, too. It's not just investors, either. It's the mainstream press.
Case in point: Mentions of the phrase "Housing Recovery" in news articles went completely vertical this summer. Take a look:
The only problem? Those who were waiting to see it to believe it lost out on killer profits.
More specifically, average investors who waited for real estate prices to actually increase – instead of acting when homebuilding stocks bottomed out in October 2011 – missed out on profits of about 100%.
I guess Warren Buffett was on to something when he said it pays to be greedy when others are fearful, huh?
Double-Digit Upside Remains…
Rest assured, the purpose of today's column isn't to scold anyone for being average instead of smart. Truth is, I'm no stock market Einstein. It took almost five months of rallying by homebuilding stocks for me to wise up to the opportunity. So I'm only slightly better than average on this one.
Instead, I want to encourage you to invest in the recovery before it's too late. Especially since the latest data points indicate the recovery's gaining steam.
Take the National Association of Home Builders/Wells Fargo Housing Market Index, for instance. It rose for the fifth straight month to its highest level since June 2006.
This Index happens to be a reliable leading indicator of single-family housing starts. Take a look:
And wouldn't you know it? Yesterday's report from the Commerce Department revealed single-family housing starts rose 5.5%, to a rate of 535,000 homes – the fastest pace since April 2010.
As you can see, though, a huge gap still exists between the two data sets, indicating that an even more sizeable increase in housing starts is imminent.
Translation: The recovery should pick up steam in the coming months. Especially in the wake of the Fed's decision to keep mortgage rates low.
I'm not the only one who expects the real estate recovery to accelerate, either.
On Tuesday, Goldman Sachs (NYSE: GS) issued a note to clients saying, "Our confidence in our forecast for a 20% to 30% housing activity growth for each of the next few years has risen."
Goldman's favorite homebuilding stocks are MDC Holdings (NYSE: MDC), KB Home (NYSE: KBH), PulteGroup (NYSE: PHM) and Toll Brothers (NYSE: TOL).
So, how do we play it? I'm convinced that spreading our bets is the smartest strategy at this stage in the recovery. By that, I mean investing in an ETF that gives us exposure to multiple homebuilders at the same time, instead of trying to focus on one or two homebuilders like Goldman suggests.
We have two options: the SPDR Homebuilders ETF (NYSE: XHB) and the iShares Dow Jones Home Construction ETF (NYSE: ITB). I favor the latter because it gives us more direct exposure to a real estate rebound.
How so? Well, six of the top 10 holdings in ITB are homebuilding stocks, whereas XHB only includes two in its top 10. And in terms of the total portfolio, 85.6% of the Dow Jones Home Construction ETF is invested in homebuilders and building materials stocks. The SPDR Homebuilders ETF only has 56% of such exposure.
Long story short, ITB is a purer play. Accordingly, it's rewarding investors with higher returns. Case in point: Over the last six months, ITB is up 30%, nearly doubling the returns of XHB.
Bottom line: The time to be a smart investor in the real estate recovery has passed. But all the profits have not. So don't be dumb. Now that you can see it, believe it. And then invest in it!
Ahead of the tape,
Louis Basenese