The economy is looking great in 2018. Despite the recent stock market rout, many underlying fundamentals remain very bullish. That is, all but the housing market. This significant barometer of economic health has started to slip lower. At first glance, the slowdown appears to an aberration in the overall bullish picture. However, a closer look reveals that the underlying drivers of the housing slowdown may be long term.
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Consumer confidence is soaring, unemployment is at historic lows, and wages are trending higher. By most analyses, these factors should lead to a thriving housing market. It only makes sense that happy consumers combined with higher salaries and greater employment numbers lead to soaring housing, right?
These bearish factors have resulted in the iShares U.S. Home Construction Index ETF (ITB) plunging over 25% this year.
So, is it time to short the housing market? Yes because I expect the softness to continue well into 2019 thanks to the above bearish fundamentals.
Shorting builders, particularly those that focus on the aspirational demographic, is a smart move right now.
However, this article is not about shorting. It is about several peripheral housing plays that make sense despite the market softness.
The critical way to profit from the housing industry is via HVAC stocks.
Heating, ventilation, and air conditioning companies are often not the first thought an investor has when it comes to investing in the housing sector. However, HVAC units are an integral part of every home built around the world.
According to Barron's, Tim Wolz of Baird said that homeowners would soon need to replace their old units. HVAC units last 12 to 15 years, which means that time is running out for systems installed from 2003 to 2006 -- the height of the housing boom. "We probably have a couple more years of strong replacement demand," Wolz said. About 80% of residential HVAC sales are for replacement units.
I concur 100% with Wolz's analysis and actively think that the industry is set for a growth surge over the next 24 months. Other upside catalysts include the commercial construction industry, the internet of things, and hedge fund activism. Let's take a closer look at each of these bullish factors.
First, the non-residential commercial construction business is experiencing an upward trend. Growth has averaged 8% over the last 90 days in the industry. The latest American Institute of Architects forecast revealed that nonresidential industry expenditures in the U.S. would ramp higher by just under 5% in 2018 and another 4% for the next two years.
Secondly, the shift toward "smart systems" powered by the overall trend of the Internet of Things is forcing innovative upgrades in the HVAC business. You are probably aware of NEST connected thermostats as an example of the massive innovation taking place in the industry. These changes will likely lead to higher revenue in the long run for the industry.
Finally, noted activist hedge fund manager, Dan Loeb of Third Point had purchased a $1 billion stake in United Technologies which owns the HVAC brand Carrier. Loeb's goal is to break the company into three stand-alone firms. Of course, there is no guarantee that this will be a bullish change or even if it will occur.
However, the fact that Third Point purchased a stake in United Technologies is a very positive sign!
The three stocks I like best in the space are United Technologies, Lennox, and Ingersol Rand. Let's take a brief look at each of them.
1. United Technologies (NYSE: UTX)
Shares of this diversified conglomerate are lower by around 4% this year. Loeb's interest mentioned earlier, and the overall expected growth in the HVAC business should help the shares climb from the current levels.
2. Lennox International (NYSE: LII)
Climbing 6% on the year, shares of this climate control solution company has a significant potential catalyst to push shares higher.
Morgan Stanley recently reported on a possible Carrier/Lennox deal could lift the stock north of $250.00 per share from the current $220.00 zone.
3. Ingersol Rand (NYSE: IR)
The best performer on my list with 15% plus returns this year, IR has averaged 17% plus returns annually over the last eight years. I expect this upward trend to continue due to the bullish HVAC catalysts in play.
Risks To Consider: The bullish projections are subject to the economy continuing to improve and no interest rate shocks from the Fed. Always use stop-loss orders when investing.
Action To Take: Consider adding one or more of the above stocks to your long-term portfolio.