Jan

29

The Homebuilders: Climbing The Wall of Worry?

By Pete | Filed Under Trading Ideas | Start a Discussion 

29-xhbanimated.gifYou may have noticed that 6 out of 26 winners in yesterday’s “Stocks to Watch” list were involved in the home building industry.

Yes, we are talking about a sector that has been crushed, the scapegoat for the current economic woes. Yet there is interesting price action. Let’s tak a look at these six companies in context of The Sentiment Cycle.

Emotions are a huge big part of the investment process. To succeed in the long run, we have to become Zen Masters in the financial media circus. The media may say one thing, but what truly counts — the price action — provides us with timely insight.


The phases we will focus on today is Discouragement and Aversion and Wall of Worry:

DISCOURAGEMENT AND AVERSION
After a long price slide, the area where churning takes place is between the Discouragement and the Aversion phase, after a significant decline has already taken place. Often, this appears as a head and shoulders bottom, a cup and handle or a saucer dish pattern. As the public continues to dump stocks, short sellers become bold and bearish. Their views are supported by bad news and poor economic data. Prognostication of lower prices to come is undoubted. This is when everyone knows that the market cannot ever go up again, and that anything, even cash, is preferable to owning stocks.

The home builders sector has been nothing but one big continuous negative story for a very long time. In 2007, stories by the financial media were overwhelming bearish towards home builders. Let’s check the headlines:

  • D.R. Horton Expects 2008 to Be ‘Worse’ Than 2007
    The new-home market will deteriorate next year as the number of foreclosed properties for sale rises, D.R. Horton Inc. Chief Executive Officer Donald Tomnitz said.
  • Pulte backs quarterly outlook, amends credit facility
    Pulte Homes Inc.’s stock was down Tuesday in volatile trading after the home builder backed its fourth-quarter outlook and said it has amended its credit facility, while a closely watched index of home prices pointed to further deterioration in the housing market.
  • More Pain For Toll Brothers
    The White House’s attempt to calm the jittery housing market get a positive reaction from investors as the homebuilders rallied on Thursday. But Toll Brother’s quarterly earnings, although not as bad as expected, were further proof that the fundamentals may not improve for some time .
  • Some Homebuilders Could End Up Bankrupt
    Homebuilders such as Centex Corp. and Pulte Homes Inc. aim to survive an industrywide unraveling by selling houses at bargain prices, slashing jobs and scrapping growth plans. But as the housing downturn worsens, experts say at least a few major U.S. homebuilders may end up bankrupt.
  • Moody’s cuts D.R. Horton, Ryland ratings to junk
    Moody’s Investors Service on Wednesday cut its rating for home builders D.R. Horton Inc and Ryland Group Inc to junk status, citing persistent troubles in the U.S. housing market.
  • KB Home posts loss, sees tough ‘08 for industry
    KB Home posted a quarterly loss of nearly $773 million on Tuesday, including charges for shrinking land values and abandoned projects, as the U.S. housing market braced for another rough year in 2008.

It is obvious from the media stories above that home builders are currently in rough shape. When we check the definition of the Discouragement and Aversion phases, we get a good idea as to the situation that the industry is in, sentiment-wise.

WALL OF WORRY
While the broad indices are still going down, certain sectors will have bottomed. At some point, everyone who wants to sell has done so, and the selling stops. Low prices and relative value returns, and early buyers with deep pockets begin to nibble at the market. The net effect is that the major stock indexes stop plunging and begins to dribble or moves sideways.

This area is where we find a buildup of participants in position to write buy tickets, producing potential buy pressure. With sellers gone, the market even goes up on bad news. Rallies are labeled as ‘technical bounces’ or are written off as ‘short covering’. Short positions add more on every bounce, confident that lower prices are around the corner. When good news trickles in, it is summarily dismissed as aberrations, subject to revision next month.

“IF” the Home Builders are entering the Wall of Worry phase, the best way we can visually see this is via price action and compare this to the headlines. Have you noticed the media using the terms ’short covering’ and ‘Are these real bounces?’ to characterize current price action?

Let’s take a look at some examples;

  • Homebuilders rally, but will it last?
    Homebuilder stocks rallied this week, gaining favor after the Federal Reserve’s rate cut even as data showed the housing market continued to worsen last month.
  • Bear-Market Rally: An Oxymoron, Not an Opportunity
    Similarly, the XHB, the Homebuilders SPDR, closed up 10.5% Wednesday, paring the ETF’s loss to just 50% from its 52-week high. All of which suggests that short-covering played a major role in the session’s surge. Those who had profited so handsomely on their bets against the credit-sensitive financials and homebuilders found it a propitious time to cash in some of those chips. Nothing had changed so dramatically in the space of a few hours to boost the value of these enterprises by billions of dollars.
  • Sector snap: Homebuilders rise
    Demand for new homes in 2007 slowed to its lowest level in 16 years, but a continued steep decline in home prices gave investors hope buyers will budge in 2008.

As usual, the price bars of our charts are colored according to the status of our relative momentum indicator. Red = underperform. Yellow = neutral. Green = outperform. The dots are the InVivo.Stops. The 200-day moving average was been added because it is a widely-watched line in the sand.

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D.R. Horton, Inc. (NYSE:DHI)

Wall Street firms have a rating of 3.00 on DHI which Reuters equates to an “Hold“.

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Centex Corporation (NYSE:CTX)

Wall Street firms have a rating of 2.42 on CTX which Reuters equates to an “Outperform“.

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The Ryland Group, Inc. (NYSE:RYL)

Wall Street firms have a rating of 2.00 on RYL which Reuters equates to an “Outperform“.

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Toll Brothers, Inc. (NYSE:TOL)

Wall Street firms have a rating of 2.73 on TOL which Reuters equates to an “Hold“.

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KB Home (NYSE:KBH)

Wall Street firms have a rating of 2.67 on KBH which Reuters equates to an “Hold“.

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Pulte Homes, Inc. (NYSE:PHM)

Wall Street firms have a rating of 3.00 on PHM which Reuters equates to an “Hold“.

We can see from the charts that ’something’ is shaking things up. Price action tends to move first before fundamental change. There is overhead resistance above with the 200-day moving average, so as the Wall of Worry phase comes to a close, we will watch closely to see if Aversion and Denial follows.

In conclusion, as we said yesterday, “Survival of the Fittest” takes place on Wall Street. Real bottoms take a good amount of time to form, but when they do, the fundamentals and business outlook are usually shaky, so the media looks away and continues to focus on hot stories accompanied by “glowing good news”.

Last headline as food for thought: Home prices in 10 cities drop a record in Nov January 29, 2008.

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