Beware Faults in Homebuilding ETF

The stocks in the fund are capable of big moves. American Standard in particular is no stranger to big drops come earnings season. Regardless of what you think of a sector, I believe it is important to understand what is under the hood of this type of investment product.

Look Before You Short

Another reason I chose to write about this fund was to create awareness. A lot of people are interested in trying to short the homebuilders, and here is what looks at first blush like a great vehicle. Even better, ETFs are not subject to the uptick rule; that is, you can sell ETFs short immediately following a downward move in the stock's price, instead of having to wait for an uptick.

Not so fast, my friend.

A lot of the narrower ETFs do not have shares available to short, B&CP included. The technicalities of short-selling involve borrowing shares to facilitate trades. Only shares owned in a margin account with a margin debt can be lent out. The likelihood of low-volume ETFs being available is slim; I checked with three different brokerage firms and found no stock available for shorting. (Schwab volunteered that it has received a lot of inquiries about availability.)

As with most PowerShares products, options were listed right away on B&CP, so puts are available in lieu of selling short. There is no open interest on any contracts yet and very few of the series even have quotes. I would attribute some of this to a lack of awareness about B&CP.

Not Rates but Recession

In terms of S&P 500 groups, 44% of B&CP is in consumer discretionary names and 36% is in industrials. You might think that rising interest rates would hurt both sectors. But over the last three years, both groups have done well in both falling and rising rate environments.

Holding Steady Consumer discretionary and industrial stocks have done well in both rising and falling interest rate environments

Source: BigCharts.com

Recessions seem to hit both groups much harder than rising interest rates. This may put a dent in the argument that says rising rates will hurt the homebuilders.

An important determinant might be the fate of the bubble in housing prices. I can't see that there is a national housing bubble, but I do believe there is a mania. Manias are different from bubbles, and don't have to end in widespread ruin, as the Internet bubble did. Bubbles just don't come along every five years, as the media would have you believe.

When the mania does end, the homebuilders will get hit hard. You may be able to time the end, or more likely, one of my RealMoney colleagues can help you find the top. I missed the run-up and I will miss the end, whenever that comes. The lesson in that is, I don't understand the demand, as I mentioned earlier, so I have stayed away.

---

Please note that due to factors including low market capitalization and/or insufficient public float, we consider PowerShares Dynamic Building & Construction Portfolio to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

P.S. from TheStreet.com Editor-in-Chief, Dave Morrow:
It's always been my opinion that it pays to have more -- not fewer -- expert market views and analyses when you're making investing or trading decisions. That's why I recommend you take advantage of our free trial offer to TheStreet.com RealMoney premium Web site, where you'll get in-depth commentary and money-making strategies from over 50 Wall Street pros, including Jim Cramer. Take my advice -- try it now.