The government bailout of Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) in early September was a situation that was foreseen by many and yet had a ripple on the individual stocks and overall market. Both Freddie Mac and Fannie Mae fell over 80% in one day after the announcement, but at the same time the stock market rallied by more than 2%.
Bad for GSEs, Good for Market
The bailout was not a good thing for owners of common stock of the two government-sponsored enterprises (GSE), though for at least one day it was great for most stocks in the market. The reason for the market rally had to do with the fact that the fear of Fannie Mae and/or Freddie Mac collapsing is now all but gone. In essence, the U.S. government has now taken control of the GSEs and this should help solidify the mortgage market and in turn take us one step closer to a bottom in the housing market.
A major issue recently has been the inability of potential home buyers to receive a loan for a new purchase. I believe the bailout will help this issue and lessen the lending standards as more money is available for potential home buyers. If I am correct in the housing market finding a bottom in the coming months, it will lead to an improved economic situation in the U.S. and thus a number of sectors will benefit. (For more, check out The Fuel That Fed The Subprime Meltdown.)
If mortgages become more readily available and the interest rates continue to fall as they did after the bailout, one of the biggest beneficiaries will be the homebuilders. In a matter of days after the announcement, the 30-year fixed rate mortgage fell from 6.26% to 5.88%, a drop of 38 basis points in a very short period of time. I believe lower rates along with more availability of mortgages for potential home buyers will result in an increased demand for homes and finally higher prices. (For more on this trend and how it affects stock holders, read Leading Economic Indicators Predict Market Trends.)
All of the above will help the homebuilder stocks and investors have two options.
First would be to pick an individual homebuilder to buy. My favorite at this time is Toll Brothers (NYSE:TOL), the upscale builder of homes in about two dozen states. Their prices range from the mid-$200,000s to over $2 million. What I find attractive about this company is its exposure to the luxury homes and even more so its developments of active-adult communities and country club communities. As the baby boomers move out of their large homes, they will be demanding the adult communities.
The second option for investors would be the SPDR S&P Homebuilders ETF (AMEX:XHB). The exchange traded fund (ETF) is composed of a basket of homebuilder stocks and Toll Brothers is a top-10 holding. The ETF route lowers the company-specific risk for investors and at the same time offers exposure to the low-end and high-end of the spectrum. (For more on how ETFs work, check out An Inside Look At ETF Construction.)
Mortgages and Financials
If you agree with most of what you have already read, then one of the sectors that should flourish in the coming years will be the financials. Instead of taking the risk of choosing a specific investment, I suggest looking into the SPDR Select Sector Financial ETF (AMEX:XLF), which is a basket of the large-cap financial stocks traded in the U.S. The two largest holdings are two of the more stable of the financials: Bank of America (NYSE:BAC) and JPMorgan Chase (NYSE:JPM).
There are different ways to play the mortgage aspect of the bailout, but one you probably are not familiar with is the iShares Lehman MBS Fixed-Rate Bond ETF (AMEX:MBB). In general terms, MBB tracks an index that is composed of a number of investment grade mortgage-backed securities (MBS); many of which are related to Fannie Mae and Freddie Mac. The day after the bailout, MBB had its third highest volume day as it rallied a monstrous 1.9%. The increased liquidity in the MBS market along with a $4.73 total trailing twelve months distributions makes MBB attractive.
Believer or Non-Believer
If you are not a believer in the bailout helping the mortgage industry or the housing market, then I suggest you stay far away from the investments mentioned in the article. On the other hand, if you believe we are at or near a bottom, consider the above as long-term investments.
To learn aboiut the history of Freddie and Fannie and their potential danger, read Fannie Mae And Freddie Mac, Boon Or Boom?