Many homebuilder stocks, like Toll Brothers (TOL), went parabolic in April. The homebuilder index, XHB, hit 18-month highs at the time. Since flaming out, TOL is down 26%, and the homebuilder’s ETF, XHB, has sunk 23% in two months. This action further confirms the principle that parabolic moves more than likely signal the coming end of a rally, not its continuation.
Contrarians may assert that this week’s poor existing and new home sales data were well-anticipated by the market given the preceding steep slide in the related stocks. To emphasize the case, XHB rallied sharply from initial losses on the day to close in the GREEN. With the February lows successfully tested yet again, it will be tempting to further assert that all the bad news is now priced in, smooth sailing ahead.
The biggest weakness I find in this argument is that it begs the question what in the world was “the market” pricing in during the April rally? Was the market foolish then in pricing in a robust recovery based on how well the tax credits were goosing sales only to perfectly price in the present reality? I remain at a loss to explain or understand April’s sharp rally. Moreover, homebuilder stocks slid largely in tandem with the overall stock market. The significant divergence in performance has only occurred in just the past week as the S&P 500 still hovers 4.8% above its lows. So, I could just as easily argue that the stock market is just getting started marking down homebuilder stocks as part of housing-specific weakness.
Regardless of your viewpoint, there is no denying that the XHB is locked in a steep downtrend. Until that line breaks, the bias remains bearish on homebuilders. I prefer to short rallies rather than buy dips here.
*Chart created using TeleChart:
(I found Andy Sutton’s “No Surprise in Housing Dive” particularly instructive in highlighting the vulnerabilities in the housing recovery. Respected value fund manager Whitley Tilson has remained bearish on homebuilders for quite some time. Finally, analyst Meredith Whitney continues to insist a double-dip is coming in housing).
Be careful out there!
Full disclosure: long XHB puts