U.S. housing starts and permits declined in December after rebounding in November, as the steady housing recovery seen through most of 2015 lost momentum in the last month. The starts data was largely below market expectations.

Data released by the U.S. Department of Housing and Urban Development and the U.S. Census Bureau showed that housing starts declined 2.5% to a seasonally adjusted annualized rate of 1.15 million units in December from the revised November reading of 1.18 million.

Single-family housing starts declined 3.3% in the month, while multi-family starts went down 3.4%. However, housing starts went up 6.4% year over year.

The number of building permits — a gauge of future constructions — went down 3.9% in December from the prior month due to slump in multi-family permits. Building permits for single-family grew 1.8%, while those for multi-family homes dropped 13.5%. However, permits surged 14.4% year over year.

The much-lower-than-expected starts/permits data came a day after numbers released by the National Association of Home Builders (NAHB) showed that homebuilders’ sentiment index remained steady at 60 in January. Nonetheless, the index has remained in the low 60s for eight months now, indicating that overall housing recovery is on track.

Notwithstanding the softer December numbers, 2015 was more or less a good year for the housing market, possibly the best since 2007 when the housing recession set in. Full-year housing starts rose 10.8% while permits rose 12% year over year.

After a lull in the U.S. housing market in the first quarter, sales picked up in the ensuing months supported by improving economic environment and better employment picture. Job and wage growth, a recovering economy and improving consumer confidence, moderating home price gains, affordable interest/mortgage rates, rising rentals, rapidly increasing household formation and a limited supply of inventory, point to a continued strong demand in 2016.

Heightened home construction activity is also spurring demand for homebuilding materials. This is, in turn, boosting the growth prospects of companies manufacturing these products. Construction material companies like Vulcan Materials Co. (VMC - Analyst Report) and Eagle Materials Inc. (EXP - Snapshot Report); building product makers like Masco Corp. (MAS - Analyst Report) and Headwaters Inc. (HW - Snapshot Report); equipment rental companies like United Rentals, Inc. (URI - Snapshot Report); engineering design firms like AECOM (ACM - Analyst Report) and KBR Inc. KBR and security products and solutions provider Allegion plc ALLE are well poised to grow.

3 Construction Stocks for Your Portfolio

We’ve zeroed-in on three stocks in the construction sector sporting a Zacks Rank #1 (Strong Buy) or 2 (Buy). These companies are expected to gain from the ongoing housing recovery. We further narrowed down our choices with the help of our new style score system.

Our research shows that stocks carrying a Growth Style Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or 2 offer the best investment opportunities in the growth investing space.

Summit Materials, Inc. (SUM)

Based in Colorado, this Zacks Rank #1 building materials company has a Growth Score of “B.” Summit Materials issued an IPO in March last year and delivered a positive earnings surprise in the previous quarter. The projected sales growth of the company for the current year stands at 17.60% compared with the industry average of 7.94%. The long-term expected EPS growth rate for the company is 10.5%.

U.S. Concrete, Inc. (USCR - Snapshot Report)

Based in Euless, TX, this construction materials company has a Zacks Rank #2 and a Growth Score of “A.” The company has delivered a massive average positive earnings surprise of 79.76% over the past four quarters. The projected sales growth of the company for the current year stands at 14.82% as against the industry average of 7.94%.

Quanex Building Products Corp. (NX - Snapshot Report)

Based in Houston, this Zacks Rank #2 building products company currently has a Growth Score of “A.” The company delivered positive earnings surprises in the past four straight quarters with a staggering average of 179.66%. The projected sales growth of the company for the current year stands at 55.39% compared to the industry average of 7.67%. The projected EPS growth for the company is 41.95% as against the industry average of 27.85%.

Conclusion

A couple of homebuilders — KB Home (KBH - Analyst Report) and Lennar Corp. (LEN - Analyst Report) — that have already reported fourth-quarter results clearly indicate that production constraints due to labor shortages seen in the third quarter continued in the fourth. KB Home’s results were hurt by construction delays due to unfavorable weather conditions in September and October and trade labor shortages in certain markets.

These headwinds led to lower-than-expected home deliveries and revenues. Lennar also pointed out that tight labor market, limited land availability and constrained mortgage environment held back the housing recovery to some extent in the reported quarter. Lennar reported fourth-quarter results on Dec 18, while KB Home released the same on Jan 7.

Another major concern for homebuilders like PulteGroup, Inc. (PHM - Analyst Report), Lennar, KB Home and D.R. Horton, Inc. (DHI - Analyst Report) is the rising land and labor costs. This lowers margins and limits pricing power.

The tightening labor market along with limited availability arrested the rapid growth in housing production. Limited capital for land and land development has left entitled lands in short supply. This shortage is limiting home production and lowering the inventory of homes, both new and existing. While labor shortages are driving up wages, land prices are inflating due to limited availability.

Moreover, with the Fed announcing a hike in the benchmark Federal Funds target rate in December — for the first time since 2006 — mortgage rates will probably rise. High mortgage rates dilute the demand for new homes as loans become expensive. This lowers buyers’ purchasing power and hurts volumes, revenues and profits of homebuilders.

Nonetheless, the overall fundamentals of the all-important construction sector remains strong and sales are expected to pick up as the spring selling season sets in. Also, incase mortgage rates rise with the interest rate hike, we believe they should still be reasonable, keeping housing affordable.

Additionally, the Fed has clearly emphasized that the pace of rate hike will be slow and gradual. Modest hikes in interest rates amid an improving economic environment can be a net positive for the housing sector. Stronger general economic conditions can encourage consumers to form new household, leading to higher housing demand.

So don’t miss out on our three stock choices that are superbly poised to grow