Barron's Streetwise - Why Lumber Prices Are Through the Roof. Plus, ETF Stuff

Episode Date: April 23, 2021

A top timber analyst on two-by-four mania. And the head of iShares says the ETF pile-in is only beginning. Learn more about your ad choices. Visit megaphone.fm/adchoices

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that some people are just going to defer or delay projects. Welcome to the Barron Streetwise podcast. I'm Jack Howe, and the voice you just heard, that's Mark Wild. He's a top-ranked analyst at BMO Capital Markets who has spent three decades covering packaging and forest products. That makes Mark an expert on the paper business and on shipping packages, but who cares about that stuff now? Because all of the action is in wood. I'd yell timber right now, but we're talking specifically about lumber.

Meta? Lumber! Thank you. Prices for 2x4s have tripled since before the pandemic. In a moment, Mark will explain why lumber has gone vertical, and how long the price spike will last, and what it means for shares of companies that own sawmills and timberland. Plus, the head of iShares will talk to us about the next big growth driver for exchange-traded funds, or ETFs. It's not stocks. Starts with a B. Rhymes with

Fonz. How come you don't get to pay anything? How come? Because I'm the Fonz. Listening in, as always, is our audio producer, Meta. Hi, Meta. Hey, Jack. We have a packed episode, but how about we put 15 seconds on the clock for a little small talk? It's been a while. Yeah. Here we go. All right, I'll start. I think I got tennis elbow from splitting firewood.

I got a new remote for our Roku TV. I'm wearing new socks today. They've got dogs on them. I'm having a baby. I had the best sausage and pepper sandwich yesterday. Wait, hang on. What? You're having a baby person?

Yep. I'm having a boy person. We really should talk about your small talk, but that's wonderful news. And congratulations, Metta, to you, to your husband. By the way, when you say you're having a baby, you don't mean right now, right? Because we can forget about lumber. I mean, we should keep recording. It'll be great stuff for the podcast, but I can forget about lumber. I mean, we should keep recording. It'll be great stuff for the podcast, but I can take you through some breathing exercises. Someone should get hot towels. Thank you. I'm not due until next month, so we should probably stick to lumber. Lumber it is. If you're a person who buys lumber now and then from Home Depot or Lowe's, and if you bought any recently, you might have noticed that prices are way up. Or if you're someone who regularly checks the Chicago Mercantile Exchange for spot pricing

on random length 2x4s, a common cut used by builders, you've seen that prices there have more than tripled since before the pandemic. Wood panel prices have gone crazy too. And that has added more than $24,000 to the price of the average new single-family house. That's according to the National Association of Home Builders. And it's at a time when demand for houses is fierce and supply is short. Profits and share prices for some lumber players have soared too. Look at Vancouver-based West Fraser Timber, ticker WFG. It's up nearly 300% in a year. Last year was plenty profitable for the company and this year, earnings per share are expected to jump more than 80% to record levels.

To learn more about Wood Gone Wild, I reached out to a wood analyst, Mark Wild. Hi, Mark. Hi, Jack. How are you? Doing well, thanks. Is wood the new Bitcoin or what? For at least a little while. Mark has consistently ranked among the top stock pickers and most accurate earnings forecasters in the forest products industry. His nickname? Dr. Paper. Normally, he says most people want to talk to him about packaging. Now, all anyone wants to talk about is wood. In 30 years, Mark says this is the biggest run-up he's ever seen. Typically, lumber prices go up in a spike, and then they come right back down. And what's kind of different here, and I have not seen this before, is that we actually had lumber prices ramp up through last summer

into the fall. They pulled back a little bit for about six weeks in October and early November, and then they've taken off again, and they've gone even higher. And it really has significant impact in terms of how much cash these companies are generating, because they are generating a lot of cash now. I think the first quarter will be an all-time record quarter for the industry. And right now, it's looking to me like the second quarter may be even better. Market prices we all learned in economics class are determined by supply and demand. we all learned in economics class are determined by supply and demand. Mark says lumber supply has been reduced by one long-term factor and one short-term one. The long-term one is that demand

for housing was weak for about 15 years starting just after the big housing bubble. Now that we're hearing today about a 27% drop in the number of homes sold last month compared to June. 27%. That is terrible news. So some lumber producers downsized. The short-term factor that reduced supply is that at the start of the pandemic last year, lumberyards stopped ordering because who in their right mind would want to build during a pandemic? It turns out just about everyone. And that brings us to the demand side of the market. Do-it-yourselfers

have been busy. Here's Mark. So if you think about, you know, last spring, people were at home, they weren't traveling, they weren't going to restaurants, and a lot of people getting stimulus checks. And so you can see the impact of that if you go just go back and look at like Home Depot or Lowe's, you know, year over year revenues last spring and last summer, you know, they were up in the range of 20 to 30 percent. So that's part of it. The other part is demand from home builders who use much more lumber than do-it-yourselfers. House demand is suddenly booming. Home prices are now overheated, mortgage rates are rising, and the market simply needs more houses. The number of new houses being built in March reached the highest level since 2006, back around the peak

of the housing bubble. Mark says lumber prices are unlikely to stay quite this high, but they could remain elevated for years. Supply is now coming back into the market. New supply is being built. But we're kind of limited to probably about two and a half to three percent capacity growth per year. Realistically, we probably are looking at above normal prices over the next two or three years, but current prices are really stratospheric. Meta, we've talked about this. I'm surrounded by logs right now. Yeah, because you just moved, right? Right, to several wooded acres north of New York City. There were more than a dozen gigantic trees that have been brought down by storms, and I had to hire a tree crew to take down a few more because they looked dangerous. And the crew was supposed to split and stack the

wood for firewood but they bolted before finishing the job. And I got so frustrated that I guess I went full lumberjack. I bought a maul, that's a splitting axe, and something called a cant hook for rolling over logs, and a timber jack for propping them up for sawing, and I got a bigger chainsaw, and a hook-a-roon, that's for picking up wood without too much bending meta. I've become a handy hook-a-rooner. That should go directly on your Twitter profile. It might. But I'm afraid that even though lumber prices are skyrocketing, all my logs haven't made me any richer. Here's Mark.

You know, I think the guys that are making money right now, Jack are not the guys that own the logs. They're the guys that own the sawmills. Darn it. I thought this was my moment. So now, in fact, what's surprising is that kind of across the southern U.S., log prices are pretty close to like generation lows. And at the same time, we had the highest lumber prices in history. Just to be clear, the timber Mark's talking about, that's not native forest. He's talking about forests that were planted decades ago to be turned into lumber. Today, there's no shortage of those trees, just a shortage of sawmill capacity.

And that's raising prices, and that could ultimately cut into consumer demand. You know what's tough to swallow on all this, Mark, is I've got so much wood here, and I can't turn it into lumber because I don't have a sawmill, so I'm going to cut it for firewood. But then I need a massive woodshed, which means I have to go down to Home Depot for lumber, even though I have all this wood. Big lumber always gets you in the end. I think the lumber prices are high enough at this point that some people are just going to defer or delay projects. And I think that we're probably already looking at some demand destruction because prices are probably 3x trend prices right now. Okay, so what does this mean for investors? There are real estate investment trusts or REITs with exposure to timber, both

with and without sawmills and finished lumber products. And that difference matters. Rayonier, ticker RYN, is mostly a timber company. It sold its sawmills years ago. Its shares have done only a little better than the S&P 500 index over the past year. Weyerhaeuser, ticker WY, and Potlatch-Delta, ticker PCH, have timber and lumber exposure. And Potlatch has some timber contracts that are indexed to lumber prices. Now, those two stocks have done twice as well as the market over the past year. But the biggest winners haven't been REITs. They've been companies that focus on sawmills.

Here's a difficult call for investors. On one hand, share prices for sawmill owners have multiplied over the past year. On the other hand, so have profits. Look at West Fraser, the sawmill company I mentioned earlier. Even though its shares have nearly tripled in price, they still trade for less than five times this year's earnings forecast. Now, on the other hand, that level of profits probably won't last. But on another other hand, the cash pouring in today could be put to good use. Mark calls West Fraser well-managed

and says it tends to do a good job of investing capital. He likes that it has not only a Canadian stock listing, but also a US one. That's good for attracting investors. West Fraser is the number one producer of lumbers and of wood panels. Many of the top lumber companies are in Canada, companies like Cam4 and Inter4. Mark also likes an American company, Louisiana Pacific.

It's the number two producer of wood panels, specifically something called oriented strand board. When you and I were kids, it was mostly plywood, but today plywood's been largely replaced by these oriented strand board panels. So if you drive past a new construction site and you see the stuff, this stuff that looks like chipboard going up is the sheathing on a house or the underlayment on a roof. That's OSB. The price of oriented strand board has run up just like the price of lumber. Mark likes that Louisiana Pacific also makes engineered wood exteriors for houses

that resist damage or decay and can be bought in pre-finished colors. That siding business at LP, I think, is a real value enhancer over time and suggests to me that LP's relative multiple should increase over time. I've noticed they're doing the name change game. They very much want to be seen as less of a commodity company, more as a value-added company, because they went from Louisiana Pacific to I think LP building products and then LP building solutions.

Next has to be like LP lifestyle services solutions or something like that. LP Bitcoin. Investors should think carefully about the gains they've already seen in lumber stocks and how that might add to the risk of buying shares now. For those who find themselves pining for more lumber exposure but who don't want to pick stocks, there's always the iShares Global Timber and Forestry ETF, ticker WOOD. Its top holdings are West Fraser, Rainier, and Wirehouse,

and it's up 97% over the past year. And that concludes our lumber chat and brings us to our second topic, ETFs. Meta, admit it now, you didn't think I'd be able to segue from lumber to ETFs, and now I've done it masterfully, and you're blown away. Uh, yeah.

That's what they call a pregnant pause, I believe. At the end of last year, traditional U.S. mutual funds held $18.2 trillion in assets. That's more than three times the assets of exchange traded funds or ETFs. But ETFs are quickly gaining in popularity. Last year, they took in a record amount of investor cash, while traditional mutual funds said goodbye to a record amount. For folks who aren't sure of the difference between the two types of funds, maybe the biggest difference is that traditional mutual funds are priced once each day, at the end of trading, by tallying the prices of the underlying investments. But ETFs, they trade more like stocks.

They're priced constantly during the trading day, which means investors can trade in and out of them whenever they like, for better or worse. Both types of funds have versions that passively track stock indexes and ones where an active stock picker tries to beat the market. And both have low-fee and high-fee funds. And both have funds that invest in bonds and other assets. The biggest ETF player by far is iShares, owned by the asset manager BlackRock, that's ticker BLK.

The success of iShares helps explain why BlackRock stock has returned about 430% over the past decade, beating the S&P 500 by more than 150 percentage points. more than 150 percentage points. I recently had a chance to speak with Salim Ramji. He's the global head of iShares and index investments for BlackRock. I jumped right in with an ETF question. What do you say to someone who says there are a lot of ETF choices out there and many seem to do the same thing? For example, there are a lot that track the S&P 500 index, and they all kind of look the same. Clients will want to look at how well do firms track, because there's a huge amount of technology and expertise around tracking precisely to an index. They'll obviously want to look at things like fees, and they'll also want to look at the underlying liquidity for the fund itself. How easy is it to get in and out of it? And are they suffering transaction costs for the ins and outs? The lowest fees on an S&P 500 ETF, if you're wondering, are found on the one offered by iShares, ticker IVV, and on two ETFs it's tied with from Vanguard and Schwab. All three ETFs have good trading liquidity and charge a fee of three basis points.

That's another way of saying three one hundredths of one percent per year. That's my kind of investment fee. I once sat on a panel at a conference with a money manager whose flagship mutual fund was invested mostly in a basic stock index. And it charged well over 1% a year. And someone in the audience asked, why are your fees so high? And he said, because I have kids to put through college. That was a long time ago, but his kids must be taking their time in college because I looked up his fees and they're still high.

Many of his funds over the years seem to have lagged behind their benchmarks. I know, I'm saying that with the benefit of hindsight, but one of the few things investors can know for sure in advance is what their fees will be, and that's directly related to their returns. Try to take advantage of that, especially when it comes to a core holding like an index fund, where there are versions available that charge next to nothing. Okay, so I asked Salim about actively managed ETFs. That's where stock pickers try to beat the indexes with their picks instead of just tracking the indexes. Active investing is a relatively small part of the ETF market today, but Salim sees plenty of growth potential, especially for ETFs that focus on popular themes,

like the environment. Earlier in April, we launched our low-carbon transition readiness ETFs. They're actively managed, and they were the largest ETF launch in history. Funds like that are what's commonly called sustainable investing or ESG investing because investors select companies based in part on how they score on environmental, social and governance matters. $10 billion in assets. Now he's up to nearly 150 products and he just crossed $100 billion in assets. And BlackRock just published a paper showing that investors around the world say they want to double their sustainable investing exposure. With all that money pouring into sustainable funds, I'm hearing a lot of companies lately talking about their ESG standing meta. How sustainable exactly is this podcast? Are we carbon neutral?

I don't know about that. I recycle, you compost. Yes. We should talk that up more. Apart from sustainable investing, Salim says bonds are one of the biggest growth opportunities in ETFs. And I think the exciting thing about that for me is that bond ETFs are still just a tiny, tiny part of the total bond market. It's like 1.6%. And when you look at what bond ETFs are doing, they're essentially modernizing aspects of the bond market that were over-the-counter, non-transparent,

really quite expensive to transact. And they're bringing it onto exchange, they're making pricing transparent, and they're making it easier. Finally, I asked Salim about indexing and returns. Over the past decade, money seems to have flooded into index funds. And index funds have largely outperformed active stock pickers. I asked, has one of those things helped cause the other? Has all of that money going into index funds been a tailwind for index returns? Salim doesn't see it that way. He says indexing isn't what's been driving returns, in part because indexing isn't yet as big as you might think. It was 50 years ago last summer that the first index product was invented. One of our predecessor

firms invented it. And 50 years later, indexing is 10% of the global market for stocks and bonds. If you look at it as a percentage of trading or trading volume, it's in the low single digits, look at it as a percentage of trading or trading volume, it's in the low single digits, which is really where pricing and price discovery, as you know, comes from. And so it's still a very, very early days. I hadn't heard that indexing is 50 years old. I'm 49 this year. So like, I'm basically as old as indexing. Is that what you're telling me? I'm feeling older and older. I also just turned 50, Jack. So you and I are part of the indexing generation. Let's agree now to throw indexation a party when we all turn 100. All right. Absolutely. Thank you for listening. Meta Lutzoff is our producer. Meta, I'm so excited for you. You must be looking forward to taking some baby leaves soon.

And I don't want to hear any of this stuff about taking two weeks off. I know you're devoted to Barron's and the podcast and to me, but times are changing. I want you to ask for a full month off. And if management gives you any guff, you tell them that Jack Howe says he's willing to go to the mat on this one. I'll actually be out six months or more starting in a few weeks. I mean, that's, that's great. Is it septuplets? No, it's terrific. It's I will be fine here. Don't you worry. Enjoy your time off.

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