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The market finally gave us some good follow-through to the upside on Monday. With the S&P 500 up 1.4% for the month, we are working on our first positive month for 2008...and just in time for end-of-quarter performance numbers.
End of quarter impact
Anyway, over the weekend I was reviewing stocks and sectors to see where I would play a (bear market) bounce if given the chance. The homebuilders have had some of the ugliest charts around, but things have greatly improved since the January swoon. As I have noted earlier, the XHB, the homebuilder ETF, broke its steep 8-month downtrend during the sharp bounce from the January lows. But when I noticed this important move, I did not fully appreciate how significant the January lows were for individual homebuilder stocks. Incredibly, the stocks have completely reversed the housing bubble. The current downturn in housing has already wiped out all the gains that most of the homebuilder stocks earned during the bubble. Of all the individual homebuilder stocks that I follow, only Toll Brothers (TOL) retained some of its bubble gains. All the others hit prices last seen in 2001 and earlier. I have summarized the situation with the mini-charts below. The red line connects the January, 2008 bottom with the last time that price was seen for the given homebuilder. (Brookfield Homes, BHS, excluded since it went public in 2003).
This collection of charts suggest to me that the homebuilder stocks have been fully marked down for a recession in the American economy (housing itself has been mired in a recession for a while now). And THAT gets my interest. Of course, the likely recession the market is trying to price in could end up even worse and steeper than our worst nightmares, but on a risk/reward basis, the homebuilders are worth consideration.
Beazer Homes (BZH) is the worst performer on a relative, chronological basis. Its low extends all the way back 11 years. As you may recall, BZH is ensnared in a major mortgage fraud investigation. That drama must be adding extra overhang to the stock.
Now take a look at the overall structure of these charts, most starting in the late 1980s. The following homebuilders have managed to retain some semblance of multi-decade up-trends: TOL, Centex (CTX), Lennar (LEN), D.R. Horton (DHI), Pulte Homes (PHM). Another set of builders went almost nowhere for years until the recent housing bubble got started: Ryland (RYL), M/I Homes (MHO), KB Home (KBH), Meritage (MTH), BZH, and Hovnanian (HOV).
If you insist on playing with individual names (aka fire), I think you would want to go for those homebuilders who have survived multiple downcycles in housing and have maintained long-term upward moves in their stocks. I still suspect that a major homebuilder will file for bankruptcy before this is all over and done with. The folks who helped finance the ponzi schemes that propped up the run in the homebuilder stocks have failed left and right, with Bear Stearns being the largest failure of them all so far. It seems to make sense that a major failure is looming in the homebuilding industry. I cannot speculate on who, if anyone, might fail. But that prospect alone makes me prefer to use XHB to play a longer-term bounce in homebuilder stocks...at least until things shake out in the industry. Even if the stock market is trying to anticipate that the worst is behind us, housing prices are still dropping. An economic bottom in the industry cannot happen until prices stabilize and demand starts moving upward again. Indeed, the Federal Reserve has gone into overdrive trying to engineer just such an economic bottom. The work is not over if we take to heart the warning from Robert Toll, chairman and chief executive officer for TOL just seven weeks ago: "The housing market remains very weak in most areas. Based on current traffic and deposits, we are not yet seeing much light at the end of the tunnel."
The chart on the XHB is looking constructive, but we need one more big upward move for some convincing follow-through. The XHB made a new intra-day high for 2008 but retreated back under the 2008 closing high set on Feb 1st. This close also brought the index back below the 200DMA - a level that the XHB has not seen since the recent steep downtrend began last summer. Also note that the Feb 1 high has given way to two lower lows. We need to see a higher low soon. Perhaps the best technical indicator is in the positive divergence between the XHB and the S&P 500. While the S&P 500 was struggling with its multi-year low the last 2 weeks, the XHB remained over 20% above its multi-year low. The chart below focuses on the 2008 action and the break of the downtrend is not shown (click here for the chart showing the break of the recent downtrend).
Given I am sticking by my 1200 target for a 2008 low on the S&P 500 (the latest selling missed my target by 60 points, or 4.7%), I cannot ring the all clear on the homebuilder stocks. However, I am much more constructive on the stocks in this sector: I am looking for opportunities to buy. At a bare minimum, I still think this is one sector for which the shorts need to finalize exit strategies. (For additional background, check out the Fast Money folks warning you to sell into the rally, including homebuilders: "Late to the Party." Apparently, folks are exchanging stocks for in-the-money calls to reduce overall risk).
Be careful out there...!