Bottom Fishing in Housing

02/24/2009 1:00 pm EST

Focus: FUNDS

Tim Middleton, contributor to MSN Money, says housing has a way to go down, but he does suggest one way risk-tolerant investors can get in on the rebound early.

The housing collapse led the stock market and the economy into the cellar. And this crucial sector is headed deeper still, along with the value of your home.

"The problem we have right now is that our animal spirits are beaten down, and this is a fundamental problem," says economist Robert Shiller, the foremost expert on the US housing market.

And, he adds, "the [Obama stimulus plan] has a good chance of not fixing that."

If Washington doesn't dispel the gloom, Americans will remain depressed. That means a depression rather than a recession becomes increasingly likely—and increasingly likely to spur more action in Washington.

How low will prices go? The S&P/Case-Shiller index of home values nationwide has plunged 19.1% in the past year and 26.6% from its peak in June 2006, as of data for November.

Futures contracts that trade on the Chicago Mercantile Exchange forecast a further decline of 14.5% by November 2010, after which home prices likely will begin to revive. Forecasts like that help keep buyers off the market, waiting for lower prices. Meanwhile, many owners with mortgages can't afford to sell. That, coupled with tougher lending standards, will keep the freeze on.

Joseph Davis, the chief economist of Vanguard Group, judges the massive steps the federal government is making to address the current economic malaise to be "necessary but not a sufficient condition for economic stabilization. And the reason is, they do not directly address the two sources of considerable stress in the economy: One is the issue of solvency in the banking sector, and the second front is housing, and they're both related."

But a few hardy value investors have begun dabbling in property stocks, and that is the most promising development that Davis says he's seen since the downturn began.

"When value investors start to come in and see opportunity, psychology switches from fear of loss to fear of losing the possibility of profit," he says. "That's how bear markets have ended in the past."

If you're interested in dabbling, only a small number of mutual and exchange traded funds target the housing sector. My pick among them would be Fidelity Select Construction & Housing (FSHOX). It is actively managed and has significantly outperformed index rivals over the past year. Only the strongest homebuilders will survive, and only active managers can help you avoid the losers.

The Fidelity fund has lost far less than its rivals in the current rout and seems positioned to take first advantage of the recovery when it comes.

For my money, investors can find more promising opportunities elsewhere in the market, notably in corporate bonds. Psychology in that space is improving; America is not going broke. But until economic sentiments shift much more broadly, it's hard to imagine homebuilders putting up a rally.

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