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In the last two days, the stock market has digested the most recent survey reporting on homebuilder confidence, in addition to the latest housing starts data. These two reports provide a conflicting opinion on the state of the new home market. More importantly, the particularly negative headline surrounding the homebuilder confidence survey invoked a strong sell off in the homebuilder stocks. The SPDR S&P Homebuilders Index (XHB) was down close to 5% on Monday, April 15th, coinciding with the downbeat confidence report. While the overall market had a significant down day as well, the homebuilder group underperformed the broader market. The following day, April 16th, markets regained a large chunk of their losses from the previous day. The overall positive move in the market came on the same day that the positive housing starts data was released. However, the divergence in the stock price action of the homebuilder index and individual stocks is shown in the table below:

Homebuilder Price Action
Security & TickerMonday Chg %Tuesday Chg %
SPDR S&P Homebuilders(4.9%)2.0%
Pulte Group (PHM)(7.1%)4.2%
Lennar (LEN)(6.7%)2.4%

DR Horton (DHI)

(6.5%)2.5%

The price action above from Monday coincided with the downbeat confidence survey along with an overall market selloff. The price action on Tuesday coincided with the better than expected housing starts data in concert with a large move higher by the broader market.

The above price action is illustrative of how the homebuilder stocks have traded lately. When the market has sold off, the homebuilders have sold off with more ferocity than the broader market. When the market has jumped, the builders have moved up but have not been the leaders.

The key question now is to determine why this once high flying sector has dislocated from the broader market trends.

Has The Tide Turned For The Homebuilders?

The stock chart below provides the best example of how the homebuilder index has lagged both the Dow and S&P 500 over the last 3 months:

XHB ChartXHB data by YCharts

You will see that the homebuilder index has significantly underperformed both the Dow and S&P 500. You will also see that when there have been corrections in all three indexes, the homebuilder index generally corrects the most.

This stands in stark contrast with the price action that was seen during all of 2012 as shown by the below stock chart:

XHB ChartXHB data by YCharts

In 2012, the homebuilder index was the standout performer even as both the Dow and S&P 500 both put up respectable gains.

Interpreting The Conflicting Data

The disappointing data came from the homebuilder confidence survey. In a nutshell, this survey is completed by homebuilders both public and private, and gauges their sentiment as to the outlook for the industry. It encapsulates both current and future expectations across a number of different metrics. The raw confidence number for the purpose of this survey is not all that relevant, but it is worth knowing for context. The survey of confidence came in at 42 for April compared to 44 in March. Putting this in perspective, in April 2012 the confidence number stood at only 24. However, the reading of 42 in April is the third consecutive monthly decline since the runup from the low of April 2012. For purposes of measuring overall confidence, a reading above 50 is a positive outlook and below 50 is a negative outlook.

On the other hand, the housing starts data exceeded expectations and to some investors continues to confirm the housing recovery. A housing start essentially refers to a residence, single family or multi-family, having construction commenced on it. The housing starts data that was just released showed an increase of 7% over the prior month which exceeded market expectations. More importantly, the level of housing starts on an annually adjusted basis exceeded 1M units and was up almost 50% compared to the prior year. If the trend holds for the remainder of 2013, this will mark the first time in almost five years that housing starts exceed 1M annually.

However, there are a few contrarian items to point out with regards to the data point that was a negative for the sector and the one that was a positive.

With regards to the homebuilder confidence survey, the survey noted that the biggest issues that the homebuilders continue to face are in the form of higher labor and land costs. As I have gone into detail in previous articles such as this, rising costs should not surprise you as I have explored in depth how this was a headwind the market was not accounting for based on the lofty valuations assigned to the homebuilders. At the same time, the more significant part of the homebuilder confidence survey comes from the forward looking expectations. Specifically, the survey responses increased 3 points compared to the prior month with regards to expectations for future orders over the next 6 months. This was the highest reading for this metric since February 2007. This is an extremely pertinent point if you are considering investing in the homebuilder sector. While the homebuilders may be acknowledging some headwinds in the form of rising costs, the market will most likely forget those headwinds as the builders continue to report increasing order numbers. While this should not be the fundamental reason for the stocks to increase, it is highly likely the positive headlines will move the stocks higher.

As for the housing starts number, the underlying data is actually much weaker than the headline suggests. This lies solely in the fact that the increase in starts is predominantly related to multi-family residences. For most who read this data, that multi-family is interpreted to be apartment buildings. If you associate homebuilders with single family homes, this is actually a negative because housing starts for these homes were actually down 5% from the prior month.

How To Invest In The Homebuilders Now

It is tricky right now to invest in the homebuilders. The dogs of the sector, such as Hovnanian (HOV), should be avoided or shorted depending on your risk tolerance. The financially sound and undervalued companies, such as MDC Holdings (MDC), could be purchased. Buying any homebuilder would be with the mindset that the market will reward the sector if, as the confidence survey suggests, new orders continue to rise in the coming months. My suggestion is to trust the price action of the sector. Right now, it seems prudent to trade the majority of these stocks and only invest in those who have the financial stability to weather another housing correction. I do believe that the market misinterpreted the confidence survey and that if homebuilder earnings continue to reflect increasing orders, the stocks may run again. However, the fundamental outlook for the sector is still fraught with risk and investors need to do their homework and not just trust the headlines for this sector.

Source: Mixed Data For Homebuilders: But Stock Reactions Tell A Different Story